Diversified or concentrated portfolio, that`s the question Source: BUSINESS LINE (17-JAN-11)

B. Venkatesh

Mutual funds portfolios are typically diversified. Self-directed portfolios, on the other hand, are mostly concentrated. Both strive to beat the market. Or in other words, generate alpha. The question is: Which portfolio is more optimal for active management?

This article explains the role of diversified and concentrated portfolios in alpha generation. It then shows why the choice of portfolio construction is dependent on the alpha source and investment style.

Diversified alpha
Alpha is primarily generated by security selection. That is, a portfolio manager will go overweight on a security that she believes will outperform the index of which it is a constituent. There is a fundamental law of active management. It states that the Information Ratio is equal to product of Information Coefficient and square root of breadth.

Information Ratio, to recap, is the residual or excess returns divided by the volatility of residual return - the numerator captures the excess return and the denominator, the risk assumed to generate such returns.

Suffice it to know that the excess (alpha) return is a function of the manager`s skills (Information Coefficient) and her independent investment bets per year (Breadth). According to this argument, a portfolio manager can increase the portfolio`s Information Ratio by spreading her spreads across more stocks and/or increasing her skill.

A portfolio manager`s skill is captured by how close (correlation) her forecast of residual returns is to realized returns. As this variable is not so easy to improve, the manager is left to increase her independent bets to improve the Information Ratio. This is the reason professional managers prefer diversified portfolio.

It then follows that an investor adopting traditional investment style using security selection as the alpha source should strive to have a meaningful collection of stocks to improve Information Ratio.

Suppose we define the portfolio`s risk as the total of market risk and residual risk. We can then state that market returns (beta) is the compensation for market risk and alpha, the compensation for residual risk.

Now, a portfolio`s market risk can be captured by its R-squared, which measures the completeness of the diversification relative to the market or benchmark. A portfolio with R-squared of one will have no residual risk. Research has shown that nearly a third of a typical stock`s behavior can be explained by market factors. In other words, for a typical stock, the R-squared is 0.30. But when large number of such stocks is gathered into a portfolio, the portfolio`s R-squared typically exceeds 0.90.

It follows from this argument that one way to retain more non-market risk exposure and generate non-market returns (alpha) is to have a concentrated portfolio. Two kinds of investors prefer such concentrated portfolios. Hedge funds that engage in arbitrage trades apply quantitative models to place large leveraged bets on fewer assets. Individuals managing self-directed portfolios apply technical analysis to invest in few assets to time the market.

Note that the fundamental law of active management essentially scoffs at market timers as such strategy has low Information Ratio. This is because market timers take large bets on fewer stocks and, hence, have lower breadth. The key to succeeding in market timing strategy is to have strict risk management rules to contain losses.

Conclusion
The above discussion shows that both diversified and concentrated portfolios have the potential to generate alpha. It would be optimal for those who follow technical analysis or other trend-following system to construct concentrated portfolios with strict risk management rules to contain losses on wrong bets. Those who follow traditional form of investing (fundamental analysis, for instance) should prefer diversified portfolio with independent alpha bets that do not largely cancel each other. That is, a factor that drives the excess return on one stock should not lead to negative returns on another. Otherwise, diversification can lead to tighter R-squared making the portfolio a closed indexer.

Save investors from matrix organization Source: BUSINESS LINE (17-JAN-11)

Krishnamurthy Vijayan

One of the positive fallouts of the financial crisis is that we can now question the myth of superior American systems, without losing our reputation for professionalism. Let me pick on one - the matrix organization. It tops my list of bad ideas.

Collective deniability
This structure has evolved to protect the US corporate chieftains from the consequences of their negligence. This is harmful to the most vulnerable external stakeholders i.e., small share fromety. Stringent accountability is the only check on greed, which is the pivot of every decision in their bonus-centric culture.

When the financial crisis broke, one question that was often asked was, ``How is it that the best brains in the developed world, working for the most powerful financial organizations, operating in the best regulated capital markets, blow up investor wealth in such a spectacular manner?`` The answer is lack of central accountability, embodied by the matrix organization.

What`s the matrix

The matrix organization is harmful in any business. But in the financial business, it is the most critical investor risk- he trusts his savings to a company that is run like a coalition government.

The matrix organization is a descendent of two management structures. One is the line and staff structure that the army evolved, to deal with the need for specialist inputs to decision-makers. Here, there are two lines of authority which flow at one time, viz. line authority and staff authority. Power of command, however, remains with the line executive and staffs serves only as counselors.

The second structure is the project matrix organization, which was created to deal with projects that require multiple disciplines. A company creates a flat hierarchy with a team leader and multiple specialists need to quickly and efficiently execute a project.
A permanent matrix organization, on the other hand, is a bureaucracy nightmare. In each business unit (say the Indian subsidiary) there is a CEO, who is supposedly assisted by domain specialists. But each of these specialists does not really take orders from the CEO.

They report into domain empires within the organization. Matrix organizations create a feeling of infallibility, because so many `domain experts` get pulled into making a decision. This fosters a sense of irresponsibility, because everyone believes that someone else who has approved the decision knows what he or she is doing.
Everyone is also secure in the belief that this collective decision-making ensures that the whole organization will be arrayed against anyone who tries to prove that they were wrong.

Even if this does happen, no one can be individually blamed and lose his job or worse. When a `scam` happens in India, people get arrested, cases are fought and life can become living hell for those who are involved. In the developed world, they get fat severance pays and golden parachutes.

Coalition government
In some respects, the matrix organization is exactly like a coalition government - each cabinet minister supposedly reports to the Prime Minister but in fact reports to his party boss first each of whom has his own agenda to maintain his power base in his local city or state.

Like a coalition government, again, the members come together strongly to deny any hint of wrongdoing or negligence. Indeed an external threat is the single unifying force of a matrix organization. No senior executive can be blamed for anything and the only punishment that can be meted out to the one in power is a golden handshake, though smaller fry do get blamed and sacked.

It creates deniability - witness the experience of our investors with multinational financial organizations versus domestic organizations in the various scams that have beset us from time to time. Not one multinational executive has had to face regulatory or legal action, except in the latest one where it was a clear fraud and the perpetrator has been arrested. Even here, it is interesting that the perpetrator is the only one blamed - whereas in the case of Indian institutions, the senior management faces severe action.

Protecting the investor
In India investors are feeling vulnerable and it is necessary for the regulator to think differently and ensure protection by ensuring stringent accountability at the top for all organizations.

Under Indian regulations, the directors are accountable and they take comfort from the managing director or the chief executive officer who is responsible for the acts of omission and commission of his staff; let even multinational financial businesses toe that line.

In this way, investors will get a far better deal when there is built-in due diligence and knowledge based decision making.

(The author is the MD & CEO of IDBI Asset Management. Views, opinions and expressions made are personal.)

Portfolio Analyses: Get your investment to deliver more Source: BUSINESS LINE (17-JAN-11)

I am aged 50. My wife is a homemaker aged 43 and my son is in the final year of his graduation. I am self-employed -running a medical business - and my average monthly income is Rs 1 lakh.

My monthly expenses are Rs 20,000. Besides this, my monthly commitment towards 12 mutual fund schemes is Rs 28,000.

In order to protect my family against any medical emergency I have taken a family floater health policy for Rs 3 lakh. I have taken term insurance for Rs 15 lakh. I have booked a flat for Rs 9 lakh and paid an advance of Rs 3 lakh. For the balance amount, I am planning to take a bank loan and my EMI would be Rs 10,000.

After keeping emergency funds for my business, premium towards all my insurance policies, I have an investable surplus of Rs 20,000 a month. I was working in a company till five years ago. But due to the low salary there, my only savings was in provident fund (PF).

I am planning to retire at 55 and I need present value of Rs 20,000 a month as pension. How much do I need to have at the time of retirement to take care of my family expenses till I reach 85 years?

As my son is interested in doing business, I am planning to set up a shop for him, for which I need to keep a provision for Rs 2 lakh.

I am planning to buy a car and a house in two to three years. The total outgoes for both goals are Rs 28 lakh.

Go through my MF portfolio and please suggest changes.
- Sarveshbabu.
Solutions
Time and again through this column we have suggested to individuals to follow an asset allocation that is based on their risk appetite. It`s generally observed that some individuals have an urge to building multiple immovable asset classes in their portfolio. As you are planning to retire at the age of 55, we strongly advise that you do not buy a second house, that too within few years of the first purchase.

Even in metros such as Chennai and Hyderabad, the current rental yields are 3.5-4%.
Going by the property prices at your home town, rental yields are likely to be lower than in metros and hence will not be a good retirement investment.

We suggest that you build a debt portfolio when the interest rates are ruling high and construct your portfolio in such a way that the maturity proceeds are available for consumption in the succeeding financial year after your retirement.

This would help you in better tax planning to reduce outgo.

When the interest rates are peaking, it may be prudent to start recurring deposits to enjoy higher returns.

Retirement
In 20 years of service, your retirement accumulation has not been significant.

Now, being an entrepreneur, you have the possibility of saving more towards this goal. But your accumulation period would be very short.

You ought to extend your working years to 60.

Even your current savings of Rs 28,000 a month in mutual funds will cover only 70% of your requirement and you need to increase your savings substantially to reach your goal.

As you are 50 plus, it may not be prudent to tilt all your investment towards equity to build a retirement corpus.

Your desire to have Rs 20,000 a month after retirement appears very reasonable based on the current lifestyle and on account of abnormal inflation.

Considering an average inflation of 7%, current annual requirement of Rs 2.4 lakh would be Rs 4.7 lakh in 10 years.

To have such a pension for the subsequent 25 years till the age of 85, you should have a retirement corpus of Rs 1.1 crore at the age of 60 and it should earn an inflation adjusted return of 2% to last till 85 years.

To meet this target you need to save another Rs 20,000 a month in debt funds and recurring deposits and you should ensure that you are generating compounded annualized return of 15% from equity and 9% in debt instruments.

Business and car

To set up the business for your son, you can utilize the chit fund investments and the balance can be used to pay the advance towards buying the car.

It may be prudent to buy a car by taking a loan and paying EMIs from your business income as it can help you to minimize tax outgo. Besides you can also enjoy depreciation benefits on your car and the same can be utilized to pay your car insurance.

Investment

It is admirable to see that you have picked the right schemes. But the only concern is that your portfolio contains 11 schemes and some of the schemes investment objectives are overlapping.

We recommend that you continue your investment in large-cap funds such as HDFC Top 200 and DSPBR Top 100 and in mid- and small- cap space through IDFC Premier Equity and DSPBR Micro cap.

Other SIP investments can be stopped and the money can be invested in large-cap schemes.

Continue your investment in DSPBR World Gold Fund and HDFC Prudence.

Insurance

It`s heartening to see that you have taken a term insurance for Rs 15 lakh; even so your protection is far short of your requirement. Despite working for 20 years your current assets are too low.

To reduce hardship we recommend you to take term insurance for another Rs 35 lakh, but considering the higher premium outgo and your current capability to save, it may be prudent to take a decreasing term insurance product.

For your health insurance, it is better to increase the cover by another Rs 2 lakh.

Sale of property: Taxes thereon

Author: Anil Rego

Capital gains on property have always dogged the average investor because there are numerous nuances that one should look at whilst computing capital gains on property. Property here includes residential property, land, jewelry etc.

Categorization and tax liability

While capital gains on securities are easier to compute and understand, the nuances of capital gains related to property sale is slightly more complex since the computation mechanism is different; including the treatment for short term capital gains.

Capital gains are taxed on the basis of the holding period of the capital asset from the date of purchase. One can bifurcate this assessment under short term capital gains (STCG) and long term capital gains (LTCG). Short-term assets are those that are held for 3 Yrs or lesser and those held for more than the 3 yr period is categorized qualify for long term capital gains.

Capital Asset	STCG	LTCG
Other Assets & Immovable property	Definition: Held for a period not exceeding 36 months from date of Acquisition	Definition: Held for a period exceeding 36 months from date of Acquisition
	Tax Rate: Included in Gross Total Income. Rate applicable as per tax bracket	Tax Rate: 20% with indexation + surcharge & Cess

Computation and exemption

Short Term Capital Gains: If a capital asset is sold within a period of 36 months of acquisition, the computation is fairly simple. The sale consideration is reduced by the Purchase cost and the net amount is added back into income (u/h Short Term capital gains) and is taxed at normal rates.

Long term capital Gains: Sale consideration is reduced by indexed cost of acquisition and improvement. The net amount termed as long term capital gains, can be re-invested in residential property and exemption availed u/s 54 and 54F depending on the type of asset sold.
Indexation and its impact


Indexation is nothing but adjusting the cost of purchase of units to the cost inflation index as on the date of sale. Indexed cost is calculated with the help of a table of cost inflation index that is provided by a notification in the official gazette each year. Indexation essentially adjusts cost for inflation thereby reducing the amount of capital gains.

Here`s is a simple example of how capital gains with indexation would work -

Mr. Sohan, sold his property for a sum of Rs. 60 Lakh in FY2011, this property being bought in FY2007 for ~Rs. 35.94 Lakh. The CII factor for FY2011 is 711 and for FY2007 is 519 and based on this the indexed cost of acquisition is at Rs. 49.24 Lakh. The workings are as mentioned below -

Exemption u/s 54 and 54F

Long term capital gains can avail exemption u/s 54 and 54F, these sections are applicable for different types of asset transfers and the differences / similarities of the section is as mentioned blow -

In both cases, for availing the exemption, re-investment should be made into a residential property and the same should be done within 3 years from the date of transfer (in case of construction of residential property) or 1 year before transfer / 2 years` of transfer (in case of purchase of residential property). In case one is unable to make the re-investment, the amount of capital gains should be parked in capital gain deposit scheme (prior to tax filing date) in any specified bank and enclose the proof of such deposit with the return of income.

Point of difference	Section 54	Section 54F
Asset transferred	Residential House property	Transfer of a long term capital Asset not being a residential house
Amount of exemption	Amount of investment	Amount of investment * Capital gains ; Net consideration
Additional property prior to availing exemption	Yes. The person can hold any number of house property on the date of transfer.	No. The person can hold only one house property other than the new exempted asset, otherwise he cannot claim exemption u/s 54F
Sale of re-invested property within 3 years`	The amount of capital gain exempted from tax on the original asset will be reduced from the cost of acquisition of the new asset	The amount of capital gain which is claimed exempted will be taxed as such in the year in which transfer takes place.
Nature of capital gains in case of the above default	Short term Capital gain	Long term Capital gain.

Source: Incometaxindia.gov

Hope this brief note on tax implication of capital gains arising from sale of property helps you deal with the tax woes that you face.

Money management: What it involves and how a good financial planner can help

With salaries on the rise, it is easy for a person to be lulled into a false sense of security when it comes to financial matters. Most people often forget that record levels of inflation are currently taking a big bite out of these salaries. Regardless of the state of one`s finances, there is never a bad time to create a personal financial plan - a road map that details various life goals and ways to achieve them.

These goals may vary depending on the stage of life a person is in and his or her priorities. They usually consist of saving for a home, retirement, children`s education, vacations, or a variety of other life contingencies.

The financial planning process allows you to step back and take a `big picture` look at where you stand money-wise and to gauge what types of adjustments need to be made to take you closer to your goals.

If you are tackling the exercise actively for the first time, there are a few important points to consider as you get the process off the ground.

Prioritize: Remember that not all financial goals are created equal. Scenarios that are around the corner (e.g. a child`s education) may call for more focused planning and budgeting than those that are in the distant horizon (e.g. caring for an ageing parent).
Prioritizing your goals by their order of importance is also helpful. For example, you may have a second car on your wish list, but can choose to postpone buying this while you save up for a down payment on a home.

Create a budget: A realistic and detailed budget is an excellent tool to keep your financial plan on track on monthly basis. It gives you visibility into your main expense categories and allows you to calibrate your spending levels as required.

Set a target savings rate: `Pay yourself first` is a useful maxim to live by; one that will keep you from overshooting your spending limits while making sure these are in line with your goals.

Review your insurance coverage: How much insurance coverage, such as medical and life, does one really need? The answer depends on a set of variables that includes age, health, number of dependents, and liabilities. An objective review of these factors will enable you to maintain coverage levels that are right for you.

Keep good records: Many people miss out on important tax breaks because they fail to keep records of deductible expenses. Meticulous record keeping will allow you to maximize your deductions and lower your tax bills.

Review your investment options: Combine your propensity for risk with your future cash flow requirements to select investment vehicles that are right for you. A thorough analysis of your own situation will help you create a balanced financial portfolio.

While it is possible to personally tackle some or all of these activities, it requires discipline and a substantial time commitment to make it work. A good financial planner can help you, not just in setting goals, but also in achieving them.

Experienced planners possess a comprehensive understanding of a wide range of investment opportunities. They can study your financial situation, risk tolerance, goals, future cash flow requirements, insurance needs, and investment options before coming up with recommendations and a comprehensive plan tailored to your needs. Their expertise is likely to cover several aspects of financial management, of which the main ones are:

Risk analysis and planning: To evaluate a client`s risk exposure and select appropriate risk management tools that include general, life, medical and disability insurance.

Retirement planning: To help the client with retirement planning, review their retirement employee benefits (e.g. EPF, PPF) and make recommendations to keep their contributions in line with their retirement needs.

Investment planning: To assess the client`s investment needs and risk tolerance and provide suitable solutions aimed at wealth creation.

Tax and estate planning: To guide the client through the nuances of personal taxation and estate planning, including the creation of wills, gifting schemes and joint property ownership.

Advanced financial planning: To incorporate all the aspects of a client`s financial situation in order to create a comprehensive and achievable plan.

`Caveat Emptor` or `Buyer Beware` is a guideline that applies to the hiring of financial planners, as it does in working with other professionals. While there are individuals in the field who operate based on inflated qualifications, there are also many others who truly have the credentials - recognized industry certification, relevant education and work experience, and a clean reputation - to manage your money and make it work harder for you.

The article is contributed by Ashish Prasad, director & chief executive officer (CEO), Indian Institute of Job-oriented Training [IIJT].

Market timing versus asset allocation Source: BUSINESS LINE (24-JAN-11)

B. Venkatesh

Last week, we discussed how diversified and concentrated portfolio structures are both capable of generating alpha. We also explained why market timing is risky because such strategies make large bets on fewer stocks. Several readers responded, stating that market timing was a rewarding asset allocation strategy to generate alpha. This argument raises two questions. One, is market timing same as asset allocation? And two, is it worthwhile pursuing such strategies?

This article explains how market timing is different from asset allocation. It then shows why market timing, though attractive, is risky. It reiterates last week`s discussion - market timing should be pursued by those confident about their strategies and disciplined enough to use risk management to control losses.

Market timing vs asset allocation
Market timing and tactical asset allocation involve moving in and out of an asset class. There is, however, a difference.

Market timing refers to the process wherein the investor shifts between a risky asset such as equity and cash equivalents such as money market funds.

Consider an active trader or a professional money manager who engages in trend-following strategies using technical analysis or quantitative modeling. This trader or money manager would obviously move into equity when she expects the market to do well and move out of equity when she expects prices to decline. Importantly, when this trader is underweight on equity, she is overweight on cash equivalents, otherwise called tactical cash.

Tactical asset allocation, in contrast, refers to the process of shifting between risky assets - equity and bonds. An investor would overweight equity when she believes it would perform well and overweight bonds otherwise. An investor or a professional money manager will engage in tactical asset allocation within the broad framework of strategic asset allocation.

Suppose an investor decides to have a 60-40 equity-bond allocation with a tactical range of 10% for her retirement portfolio. The investor then has a leeway to carry equity exposure between 50 and 70%.

Why is this distinction between market timing and tactical asset allocation important?

Asymmetric returns

Bonds provide higher returns than money market instruments. This means that market timing carries higher levels of underperformance risk compared with tactical asset allocation.

The flip side is that market timing also carries potential for higher reward because of its larger exposure to equity. The question is: Should investors engage in market timing?

Empirical study conducted in this area argues that market timing is risky. There are two reasons to support this argument. One, if the investor or the professional money manager misses the days when the market finishes markedly higher, which happens for about 20%  of the total trading days in a year, the portfolio is likely to underperform its benchmark. And two, if the investor or the money manager is invested on the worst days, the chances of the portfolio recovering losses becomes difficult. This is because of the problem of negative returns-compounding.

Suppose a portfolio is currently worth Rs 15,000, gaining 50% in one year on an initial investment of Rs 10,000.

This portfolio has to give up only a third (33%) of its value to end-up with the initial investment of Rs 10,000.

If the portfolio instead declines 50% in one year to Rs 5,000, it would then require 100% gain to end-up with the initial investment of Rs 10,000! The loss-recovery process is, thus, steeper. And this makes market timing risky.

Conclusion

Market timing is nevertheless rewarding, which drives investors to engage in such strategies. It is, however, important to consider associated risks.

No amount of technical analysis or quantitative modeling is likely to help investors avoid losses due to noise trading. Strict risk management rules are necessary to control losses; for it is the management of losses that differentiates a successful market timer from the rest.

Indians as money managers Source: BUSINESS LINE (24-JAN-11)

We Indians like to rank ourselves among the best in the world at writing software codes or launching space programs, but how good are we at managing our own money? A study released last week by ING, the leading global financial services group, shows that we aren`t as good as we think.

Yes, Indians are more financially literate than their global peers, but slip up when it comes to action on managing their finances - they either postpone decisions or idle their money in savings accounts. These results emerge from the ING Financial Literacy and Consumer Resourcefulness study conducted in collaboration with Epiphany Research in November 2010; it surveyed 5,000 people spread across 10 countries.

At the start of the survey, Indians exuded confidence about their money skills, with a whopping 84% of the respondents claiming they were `rather` or `very` good at managing money. People in other countries were much more diffident with only 59% claiming this.

But that sentiment changed drastically after Indians were put through tests on financial literacy and how they handled their budget, savings and investments. Once they completed the survey, a whopping 57% of the Indians admitted they weren`t `stars` at managing money.

We are, however, good at acing tests. So the majority of Indian respondents got the right answers to trick questions like, ``Tom buys a financial product with which he loans money to a company. What product did Tom buy?`` or ``Is a 1% return compounded on a monthly basis better than 12% compounded yearly?`` (Answers: bond and yes, respectively).

The study showed that 55% of the Indians surveyed had basic financial literacy, ranking 2 {+n} {+d} among 10 countries.

Indians showed great keenness in wanting to become better at managing their finances. However, they seemed to run into a roadblock when it came to actual action.

Between 30 and 40% of the people surveyed said they were prevented from managing their money better as: a) They needed help but were clueless where to get it b) They tended to postpone decisions and c) They didn`t know where to start.

The survey showed that Indians manage their household budget and spending quite meticulously. Nearly two-thirds of the people said that they carefully tracked their finances and made financial decisions only after research.

Indians were also very likely to make a monthly household budget (84% had one) and stay within it as well (87%).

The survey also showed Indians to be much more comfortably placed with respect to their finances than most global counterparts. For one, only 13% of the Indians said they did not have any cash stashed away for emergencies (a third of the global respondents didn`t have any such fund).

Two, Indians were able to spare 20% of their monthly income towards savings, against the global average of 12%. Three, quite a few Indian respondents (41%) felt they weren`t likely to run out of money at the end of the month. Over half said they could fall back on their nest-egg even if they did.

Having firmly established that Indians are big savers, where do they tend to put all that money? Well, this is where they seemed to take a rather passive approach.

While most Indian respondents (95%) owned a savings account and life insurance (84%), far fewer had a pension plan (43%) or an investment product (58%). Life insurance probably figures there because insurance agents are thick on the ground. A full 20% of the respondents admitted to not saving for retirement.

So to draw our own interpretations from this survey, here are a few messages for us Indians:

You may not be as good at managing your money as you think you are.

Get better at money by shaking off that inertia. Seek advice and act on it.

Don`t let a rising pay check and big bank balance lull you into a false sense of security about the long term. Remember, you have to contend with much higher inflation than your cousin in the US. Start moving money out of your savings account into investment options that can earn more.

Think seriously about retirement.

Savings tips for young earners Source: BUSINESS LINE (24-JAN-11)

Janani and Ajay, both in their early twenties, have just begun enjoying the perks of financial freedom. But their respective parents want them to develop a savings habit early into their careers. While Janani`s father wants her to buy a traditional life insurance, covering a major part of her salary surplus, Ajay`s father wants him to pre-pay his education loan at the earliest. Though both parents are right in emphasizing the importance of savings, their suggestions may not really be the best thing. Here`s a brief guideline on how first-time earners can deploy their monthly surpluses effectively.

Insurance: It is not uncommon for first-time earners to buy traditional insurance plans, but most do so without evaluating their merits. Young investors should understand that insurance is for protection and not an investment product, as such. The return from traditional products such as endowment will not even offset inflation, hence it`s not a good investment option for young investors. If you don`t hail from a wealthy family, it is prudent to buy term insurance. Term policies do not give maturity benefits at the end of the policy term, but ensure that the family has financial support in the event of the policyholder`s death. And given the age factor, premiums for term insurance are quite low, making them easily affordable.

For instance, for a 21-year-old male, looking for a sum insured of Rs 25 lakh, the annual premium outgo would only be Rs 3,000 for a 30-year term (young women can get the same for a couple of hundred rupees less). The premium outgo is constant throughout the term of the policy. In contrast, in an endowment policy, even for a sum assured of Rs 2 lakh, the premium outgo will be Rs 9,400. It may also interest you to know that the premium paid for term insurance is allowed as deduction under Section 80C.

Accident insurance: It is also advisable for young adults to have a personal accident cover plan. It`s specially designed to protect you from the following unforeseen events - death, total disability and permanent partial disability. This comprehensive policy will help your family meet its financial commitments in the hour of need. For a cover of Rs 5 lakh, the annual premium will only be Rs 590. And if you aren`t covered under group health insurance, do insure your family.

Credit cards: Some of you may have come across reports of this person who has 66 credit cards! But what`s interesting here is that not only was he effectively managing them all but he was also making profits out of them. The lesson here is that if you aren`t disciplined enough, plastic money can be a curse! Considering their revolving credit concepts, you may end up paying exorbitant interest rates if you aren`t organized.

So, however fashionable it may be to flash your credit cards to buy merchandise, remember to keep your spend well within your means. After all, though credits cards don`t have a bearing on your immediate cash flows, there is no escaping paying them. So ensure that you swipe your credit card only for the amount you are comfortable paying up in that billing cycle.

Emergency fund: Gone are the days when job security was a given. Besides, it is very common for young people to hop jobs or opt for higher studies. It may, therefore, be prudent to set up an emergency fund to fund your requirements during the transition period. You can build the fund by allocating a particular amount every month towards the emergency fund. Make sure that any point in time the emergency funds amount to 2-3 months of your salary credits.

Education loan: With education costs skyrocketing, parents are increasingly taking bank loans to send their children to good colleges. And since education loans are offered with a moratorium period, most parents are eager to close the loan once their wards take up jobs. With interest rates going up to 12%, while it does make sense to repay the debt, don`t rush to repay the loan with your entire surplus as you get tax benefits on such loans. It is important that you understand the priorities and spread your surpluses accordingly.

Tax Planning: By planning your taxes well, you can avail the maximum tax benefits as provided by the income-tax Act. But since each tax planning instrument has a different investment objective, you will have to understand it well before investing. More often than not, individuals give up investment strategies to avail tax benefits. For instance, young investors invest in NSC or bank deposits (interest 8.5%) in the last month of the financial year rather than investing in equity linked saving scheme (ELSS) where they have potential to earn higher returns with lower lock-in period. The category average five-year return of ELSS is 16% against 8.5% for FDs. Also, avoid planning your taxes at the last minute.

Investment: Young investors should understand the risk of investment before committing to it. While it is not advisable to invest in equities before understanding their dynamics, it is not advisable to stay away from them either. Investments in equities, spread over the long-term, have the potential to deliver significantly! And if you aren`t keen on taking up direct exposure to equities, you can consider investing in mutual funds. You can start a SIP on any mutual fund scheme with a good track record. A sum of Rs 3,000 a month can become a crore in 30 years if the fund returns 12% per annum. The savings can also be utilized as margin money while taking a home loan ten years later.

Don`t put all your eggs in one basket!

Don`t put your eggs in a single basket, cause a single rotten egg spoils the entire basket!

The world of investing also replicates a similar phenomenon. Guru`s in the investment world have always advised to invest in various asset classes to reduce the risk of eroding the portfolio value. This article explains the types of risks in a portfolio with an example of how you can reduce your portfolio risk to certain extent by diversifying your investment portfolio.

Components of risks in a portfolio...The total portfolio always comprises of two types of risks, which comprises of mainly two components:

The first one is the market risk comprising of interest rates, recessions and wars. Though classic guru`s have strongly propagated that this cannot be eliminated, experts in the investment world can apply special hedging strategies to reduce the currency, inflation, tax and regulatory risks. However, you cannot eliminate the risks associated with natural disasters.

The second is the unsystematic risk which is also called stock specific risk. To explain in simpler words, if a company launches a new product in the market and it is successful, the revenues of the company will increase leading to an increase in the share price; however, if the product fails, it is likely to be called back and the news is more likely to have negative impact on the company`s share price.

While systematic risk is cannot be reduced, unsystematic risk is the one which is reduced by diversifying your investments. We shall explain how.

To understand the disastrous effect of parking your investments in one basket, let`s take an example:

I have with me Rs 10,000 to invest in equities and I buy 200 shares of a speculative stock trading at a price of Rs 50. If the price of this stock falls by 50%, say to Rs 25, the value of the portfolio (suppose it contains only two stocks) will fall to Rs 5,000 (an equal proportion).

Let`s take another case, where I have the same amount that is Rs 10,000 which is partly parked in a speculative stock (200 shares @ Rs 25) while the remaining amount (50 shares @ Rs 100) is parked in a defensive company. Now suppose, the price of the speculative company falls 50% to Rs 12.50 and the price of the defensive company stays at Rs 100, the total fall in the portfolio value will be Rs 7,500 (12.50*200 + 50*100). You minimize your loss by Rs 2,500 by investing in two companies rather than 1.

Diversification, which simply means parking your investments in various investment instruments, surely helps in reducing portfolio risk!

However, the English idiom - No pain no gain applies to the world of investing as well. The higher the risks, the more are the returns. But the question is goes you want take?

Each person has a different risk bearing appetite. A young investor who still has long yours to live and earn surely is able to bear a lot of risk than a near retirement employee whose earning capacity is less than his predecessor. Thus, a there is always a trade-off which occurs between expected returns and the amount of risk you want to take.

If you are a high risk taker, you will definitely have greater proportion of your investments in equities. In such cases, your risks can be reduced by adding more stocks in your portfolio. How many stocks should you add? Academic studies have shown that as the number of stocks in a portfolio increases, the portfolio`s risk falls towards the level of market risk.

Conversely, a low risk taker will invest less proportion in equities and greater proportion in low risk bearing instruments like bonds, commodities and real estate’s investments (which is also called diversification of asset classes). Again, the proportion of each asset class in the portfolio will depend on the investor`s goal and his risk bearing appetite.

Ultimately, the decision lies in the hands of the investor on how he wants to choose his portfolio prudently in order to earn maximum returns with minimum amount of risk!

Tax planning - Avoid last minute investment

We are into last quarter of financial year 2010-2011 and most of the taxpayers will be looking for tax saving instrument. It is a long history that most of the people plan at the end of the year and end up buying instrument, which may not be in line of their financial need. Nearly 70% of the life insurance business happens in the last quarter of the year and this quarter is like a season for insurance professionals. We all know very well that every year we have to save 1 lakh for tax benefits u/s 80-C of the income tax act, but still we wait till end and end up buying wrong product. It is not at all advisable to wait till end for getting tax benefit. But, still if you are looking for tax saving instrument than here are some tips for tax planning.

> Calculate what the exact amount is still pending for investment to get the benefit u/s 80-C. If you are not sure than consult your CA or tax consultant.

> Buy term insurance, which is very much important and has to be given top priority. Calculate exact cover you require and buy risk cover for the protection & security of your family.

> Avoid other insurance products, as you will be not having time to assess and compare the products for the long-term benefit of yourself and your family. Insurance products are loaded with irrecoverable charges, which need to be assessed & analyzed. Do not commit yourself for long-term premium payments unless you very well understand the features of products you are buying.

> Finalize your asset allocation and be sure where your investment has to go. Whether you would like to go for risky products for higher returns or want capital protection fund.

> Business man and professional must consider P.P.F. investment for tax saving, as it gives 8% tax free returns which are the best in debt category. You can deposit up to Rs. 70,000 per annum in one financial year.

> Principal payment of your home loan EMI is also eligible for tax benefit.

> N.S.C. interest is also eligible for tax benefit but the interest is also chargeable to tax as income from other source. 

> Tuition fees for two children`s are also eligible for tax benefit.

> Mutual fund ELSS schemes are best for those who would like to invest in equity and want to participate in growth story of India. ELSS schemes have lowest lock in period of 3 years.

> Do not buy any fixed income instruments with lock in period of 5 years. Rather invest in ELSS schemes of mutual fund, as the 5-year time horizon is very good for equity investment.

> You can also buy health insurance products or increase your family cover for mediclaim and get additional tax benefit of Rs. 15,000 u/s 80-D of the income tax act. 
You also get additional Rs. 15,000 benefit for covering your parents (Rs. 20,000 if they are senior citizens).

> You can also avail the benefit of investing in infrastructure bond for onetime benefit for F.Y. 2010-2011 u/s 80-CCF up to Rs. 20,000.

Investment resolutions for 2011

Author: PV Subramanyam

However is a good list of resolutions that you can make - it is really useful if you made it already, just reiterate it, and follow it! So here it goes:

1. I will write down my financial goals - NOW, IMMEDIATELY.

2. I will convert a big portion of my savings into investments - especially because I am young!

3. I will live a simple, frugal life by choice - but choose my dream career.

4. I will start saving / investing for my retirement - NOW IMMEDIATELY.

5. I will have regular conversations about money, saving and investing with my colleagues, friends, spouse, kids and parents - all people for whom I feel financially responsible.

6. I will not deal in direct equity with my current level of knowledge of equities.

7. I will increase my financial knowledge - inter-alia by visiting www.subramoney.com , www.myiris.com and such other sites.

8. I will maintain my income and expenditure details diligently and keep reviewing them.

9. I will maintain proper records of my assets and liabilities, understand the risk of each asset class, and do proper asset allocation.

10. I will protect all those people dependent on me. Will review my term insurance, medical insurance and retirement and make sure it is up to date and adequate, and the nominees are current.

Here are some more resolutions - on the will not do side!

1. I will not buy anything on a credit card unless I can pay it off in full on the due date.

2. I will not buy any product before I understand the why, when, how of the product.

3. I will not buy things or services to show off to friends who are also doing the same!

4. I will not buy a `branded` product unless I can see the Value in what I am buying.

5. I will not change jobs just to get a higher salary.

6. I will not invest in any financial instrument without increasing my knowledge.

7. I will not buy any asset beyond my means hoping to pay a higher EMI from an increased income.

8. I will not mix my investments with my insurance IMMATERIAL of how attractive the transaction looks!

9. I will not marry a person who is financially incompatible with me.

10. I will not assume anything in the financial world- will check using present value and future value before taking a decision.

11. I will not buy a house `because it is conventional to do so`. Will buy a house when I am convinced that I am planning to stay in it for more than 10 years at least!

Most important: Properly stick to all the resolutions!

Take the easier path to wealth creation Source: BUSINESS LINE (10-JAN-11)

Most salary-earners believe that wealth-building is only for the ultra high-net-worth individuals. After all, doesn`t money beget money? However, wealth creation is really not just for an exclusive club of ultra-rich individuals. Anyone can build wealth through planned investments over a long period of time.

However, unless you have strategies in place you are leaving wealth creation to chance. The fact that ultra HNIs achieve higher returns than middle-income individuals owes a lot to their asset allocation pattern. There may be several strategies to build wealth. However, we draw on real-life examples to arrive at four basic tenets that will guide you in your pursuit of wealth, even as you avoid the cardinal mistakes some people commit.

Invest based on life cycle
Most people tailor their investment and savings habits to the experiences of others. Take Rajesh Mariappan, an IT professional in his late twenties, who reveals that since his father lost quite a lot of money during the stock market correction in 2000, he himself never invested in equities!

The fear factor made Rajesh opt for an ultra safe portfolio, with all his savings in debt investments earning an average interest rate of about 7% per annum. Inflation and taxes have since whittled down these returns to nothing, with the result that Rajesh has been saving diligently, but has built no wealth in the past six years.

Individuals should base their investment preferences on their own life stage. Investors in the age group of 20 plus can take higher exposures to risky asset classes such as equity compared to those in their late 50s, because they have the ability to wait out any market corrections. Those having a long working life ahead of them with financial goals 10-15 years ahead should include equity in their portfolio. Due to the compounding effect and lower taxes compared to pure debt investments, equity can help one build wealth at a faster pace.

So this is Rule 1: Investment strategies should be tailored to one`s needs.

Know thy risk
Risk-profiling is the first step towards asset allocation. Each asset has a different risk profile and the investor needs to understand and choose from among options based on his own risk appetite. Having chosen a particular option after understanding the risks, one should avoid changing the allocation unduly because those risks actually materialized!

Many individual investors, for instance, booked profits in stocks after the initial run up in this bull market and have not been able to re-enter market at prevailing prices due to a dilemma about whether the market is too risky to enter. Now, investors with a 10-year horizon and keen on building wealth should not drastically reduce their equity exposure on small market blips.

Take the case of Bangarappa, who holds a business administration degree. On the advice of his broker he promised his father that he could double his retirement money in the short term by investing in derivative instruments. He invested the entire Rs 16 lakh of his father`s retirement proceeds in late 2007 in stock futures. When the market crashed, his portfolio was worth just Rs 3 lakh, effectively decimating his father`s savings and jeopardizing his sister`s marriage. While equity investments or derivative exposures may be suitable for people with a high-risk appetite and a big surplus to spare, they certainly aren`t a parking ground for retirement savings.

Being over-cautious can have its pitfalls too. Mutual funds are meant mainly as long-term investment options. But in 2010 retail investors have continuously withdrawn money from such funds on every rally. Having withdrawn Rs 170 billion from MF equity schemes while market was rising, they may have lost out on an opportunity to make the best of the rally. Ultra HNIs and foreign institutional investors, on the other hand, continued to pump in fresh money and made big gains in the rally. This explicitly shows that if investors don`t understand the risk implied in their investments, they may move in the opposite direction of the trend and fail to build wealth.

Rule 2, therefore, is: Be comfortable with the risks before investing in an asset class

Know where to use leverage
In an easing inflation scenario, leverage can help build wealth quickly. However, investors should be cautious in knowing where to use debt and how much leverage to take. Salary earners often fail to make a distinction between using leverage to buy `lifestyle` assets and appreciating assets.

Lifestyle assets such as an owned home, car, a plasma television or other electronics gizmos may improve your quality of life, but they do not help build your long term wealth. Wealthy people may create lifestyle assets by liquidating other investments, but salaried individuals borrowing to fund these buys may be saddled with large EMI repayments for several years at a time. That precludes investment in other appreciating investments such as shares, debt or even rental property. A decade ago the average age of the individual taking a home loan was 40-plus, whereas this has dropped to 30-plus today. That suggests that investors commit a large part of their earnings to a home loan repayment very early in their career. Investors paying 50-60% of their gross salary as EMI may, due to limited surplus failed to invest sufficiently in stocks, mutual funds or other appreciating assets.

Take the case of Chennai-based young couple Sathish and Priya, in their mid-thirties, who bought who their first house five years back and then added on a Rs 20-lakh plot of land five years later. While the home is self-occupied and the land may yield appreciation over the long term, their investment plan suffers from a key defect. Both their investments are leveraged and take away a good portion of their monthly earnings. More important, both their investments are in a single asset class - property. If property prices were to grow very slowly over the next 10 years that would certainly impact their wealth. Over-exposure to one asset class can be a hindrance to their wealth building exercise if equities or debt outperform over the next 20 years.

Thus, Rule 3: Unplanned debt will eat away growth

Diversification
No asset class is guaranteed to deliver uniform returns from year to year. The key benefits of diversification are that even if one asset class underperforms in a specific year, the others will make up for it. So, the secret to building wealth with reducing risk is diversification. For instance, in the last five years, equity, debt, real estate and even crude oil all witnessed a bumpy ride; gold is the only asset class that has delivered a consistent return from year to year.

A bit of gold in your portfolio may have helped even out the bumps while the stock market crashed or interest rates fell. However, what percentage of the portfolio should be allocated to each of these assets is based on the individual`s risk appetite. One common mistake individuals make is, however, in diversifying too much within the same asset class.

Raghavendar, a businessman, has an equity portfolio of Rs 15 lakh. With mid-cap stocks rising last year, he took a further Rs 5 lakh loan by pledging his shares and invested this sum in mid-caps too. In November, his mid-cap portfolio had lost 30%. He now faces a double whammy where he needs to pay interest on his loan and also suffer portfolio losses. Many investors own more than a dozen equity funds in their portfolio. Now that leads to duplication of stocks and may not materially lower the risk, even as it increases your hassles in tracking your portfolio.

Rule 4 says: Don`t put all your savings in one asset class. Always keep room for a surplus to diversify

Zeroing in on an advisor
Do you ever wonder why individuals and corporate investors are duped time and again when they set out to mint money? Two major reasons for financial scams are: lack of prudence and financial literacy. The Organization of Economic Co-operation and Development (OECD) discovered, in a research exercise, that financial literacy is very poor, even in developed nations. For instance, only 18 per cent of investors surveyed in the US were able to calculate a compounded return on their investment!

This makes it imperative for individuals to acquire a basic level of financial literacy before setting out to build wealth. Assuming that a good number of investors will need the help of advisors to build wealth, how should they go about selecting one? An individual needs to evaluate the advisor with some hard-hitting questions.

1. Gauge his intentions: Try and gauge the advisor`s intentions in your first meeting. Is he paying attention to your needs and goals? Or is he simply keen to sell products that may suit his purse?

2. Check the credentials of the advisor: He should have financial qualification such as Certified Financial Planner, MBA with statutory certifications such as AMFI and IRDA. Do check whether your advisor is able to respond to your clarifications on the spot or takes a long time to get back. If he seeks time repeatedly, he is a generalist and may find very difficult to construct right portfolio. Whereas a specialist will be in a position to suggest modifications to your plan based on your risk appetite. If your advisor asks you to sign on blank application forms or asks for signature on white papers, be careful and do spend time to evaluate him.

3. Know how the advisor is paid for the service: In a scenario where most financial products are broker-driven, most of the advisors are paid by the financial product vendors. Ask for disclosures on how the agent is getting his commission and whether it is from the product manufacturer. Check whether he is ready to put everything in black and white.

4. Risk management: Ask your advisor what risk management systems are in place in the event of a crisis. When a plan is given, ask for more options and check whether these are suited to your risk appetite.

5. Decide between institutional and independent financial advisors: Institutions score on technology platforms, upgrading their skills with help of internal training and some of the products that are exclusively available to the institutions from the financial product manufacturers.

But the drawbacks of such institutions are target-based selling of products without too much customization. Frequent churning of advisors too can be a problem; when new advisors take charge of your portfolio, it may undergo unnecessary modification or the new advisor may not understand on what parameters the portfolio is constructed.

Independent advisors too are motivated by their own revenues but have fewer `targets` to meet. If you are smart and insist on an engagement letter, mis-selling could come down to greater extent with independent advisors. Unless the advisor discontinues his business, continuity too will not be a problem. However the disadvantage with individual advisors is that they may not upgrade to the latest technology and may not have access to the kind of specialized products sold by institutional advisors.

Time to lock into high-yield fixed deposits Source: BUSINESS LINE (10-JAN-11)

The year 2011 has already brought cheer to bank depositors who had to contend with low interest rates for more than 21 months now. This New Year, State Bank of India (SBI) has come up with yet another round of rate hikes; second time in less than a month which make the rate of interest relatively attractive for a retail depositor. Around 10 banks have hiked deposit rates over the last fortnight.

ICICI Bank, IDBI Bank and State Bank of Patiala, taking cues from SBI, hiked their rates to protect deposit base. However, some private sector banks, which had pre-empted deposit rate hikes, may have to come up with another round of hikes to attract retail depositors as their rates are only marginally higher than that of SBI. All in all, this signals a good time for depositors who were grappling with negative returns (adjusted for inflation) and may now see a positive real rate of return (assuming the inflation moderates from current levels).

Here we discuss some of the deposit options investors can consider to make improved returns.

The RBI, in 2010, continued its monetary tightening in order to rein inflation and in the process the effective policy rate has gone up by around 300 basis points. This rise in policy rates hadn`t deterred banks till second half of the year, thanks to surplus deposit inflows the preceding year. However, the deposit growth waned and demand for credit started picking up subsequently.

While there have been three or four hikes in deposit rates by banks, these were only in the shorter maturities as the banks were expecting liquidity to ease by the year-end. However, with liquidity not easing sufficiently, certificate of deposit rates shot up to as high as 9.75%. Hence, the deposit rate hikes to attract retail depositors.

Special deposits attractive

This time around, hikes were between one-year and three-year maturities. Additionally, the special deposit schemes are looking attractive.

For instance, SBI has hiked rate of interest (ROI) on its 555 days special deposit scheme by 175 basis points in the last four months to 9% which gives a post-tax annualised yield of 8.1% for a retail depositor (in the 10% tax bracket). Such rates in term deposits were last seen in March 2009. Subsidiary State Bank of Patiala is offering 9.25% ROI for the 555-day deposits. There are various attractive schemes from other banks - namely the 9%, 400 day-scheme from City Union Bank; 9.5%, 500-day scheme from Karur Vysya Bank; and 9%, 500-day scheme from IDBI Bank (refer to table for other special deposit schemes).

For longer term investors, IDBI Bank has an attractive 1100-day deposit with 9.25% ROI for a normal depositor and 10% for senior citizens.

Other options

Corporate and non-banking financial companies` deposits are yet to get re-priced to reflect their rising cost of borrowings from banking sector. Sundaram Finance, after raising its deposit rates recently, has an 8.75% rate of interest compounded quarterly on its one-year deposits. This cumulative option is relatively safer among NBFCs.

For investors looking for more than five years of fixed income options, the deposits begin to look attractive. With recent round of rate hikes, the five-year tax saving deposits has become more attractive than infrastructure bonds. For instance, the tax saver schemes of IDBI Bank and City Union Bank have interest of 8.5% and 9% as compared to 8% rate of interest for a buyback option in IFCI Infrastructure Bonds. Therefore investors who haven`t exhausted their 80 C are better off using these higher rates to lock-in, before considering 80 CCF option (Infrastructure bonds). There is also another long-term SBI retail bond issue on cards. With rising interest rates, NBFCs may also come up with NCD issuances as they did in 2009.

Outlook
In the weeks ahead, more banks are expected to hike deposit rates. Smaller banks may hike rates to make deposits a little more attractive than that of SBI.

The probable easing of liquidity pressures by the end of this March quarter and traditionally lower demand for credit in the June quarter will reduce the likelihood of more hikes in deposit rates. However, any threat from inflation will warrant further monetary tightening by the central bank, forcing banks to hike deposit rates.

Investors would be better off locking in to current levels as the deposit rate hikes may not be as steep from here on.

Facts beneath the factsheet Source: BUSINESS LINE (10-JAN-11)

Investing can be a rewarding exercise, especially if done in an informed manner. Of all financial products, mutual funds tend to make high levels of disclosures, usually through the periodical `factsheets`.

As the name suggests, it contains all the facts pertaining to the various fund schemes of the asset management company. While the factsheet can have a lot of details, which may seem daunting at first sight, with some guidance, they can be understood without much difficulty.

An understanding of the factsheet would allow you to appreciate the entire workings behind the single figure called the NAV (net asset value) and make comparisons between different fund houses and schemes.

Below are some of the details you will find in a factsheet and some tips to understand them. All factsheets are available in the respective fund house`s Web site.

Fund views

All the monthly disclosures start with the views of the fund house on the fundamentals of the economy, equity and bond markets in the month gone by as well as that on its expectations, going forward.

In general, these articles talk about the major events that occurred over the month, which affected the markets and the inflows. In addition, some fund houses also give an account of the sectors that they are bullish on and the ones they are not so convinced. For example, one fund house may not believe in too much cash position being taken, another may take a conservative stance during market corrections and may move significantly into cash. Also, some fund houses, for example, may be cautious in infrastructure and realty stocks, despite their being beaten down, while others may suggest that there is scope for stock-specific selection. These articles make interesting reading, especially when markets fall or gain heavily (say 20%), as fund managers dwell on what helped or went against their funds.

Portfolio and returns

Moving on to subsequent pages, we get to individual schemes and their investments in various stocks and bonds. This is the most-followed part in a factsheet as the fund discloses the stocks and bonds that it has invested in. Some funds give their entire portfolio of stocks while others give out their top 10 holdings. In a similar fashion, funds also give details of sectors they are invested in.

It is important for investors to note if the fund takes concentrated exposure to stocks or sectors as it can then peg up the fund`s risk element. Gauging the fund`s investment style, therefore, can help investors put a finger to the fund`s risk profile and match it with their own. Exposure to individual stocks to the tune of, say, 10% of the portfolio makes it concentrated. In some cases, there may not be heavy exposure to individual stocks, but greater tendency to take increased positions on individual sectors when they are `hot` in the markets.

The fund also gives the returns it generated over a period of six months, one-, three- and five-years from the date of the factsheet. For comparison, the returns of the benchmark are also given. Note that most funds also give the returns that are generated through the SIP (Systematic Investment Plan) route. This may differ from the absolute returns that a lump-sum may have generated as SIPs are spread across market cycles and enable rupee-cost averaging.

Investors can use the data so provided to check whether the fund`s NAV change over a period of time has been more than the change in its corpus size over the same period. If yes, it suggests that the fund may have suffered higher outflows/redemptions, unless there was a dividend paid out. Checking on this trend will helps assess other investors` interest in the fund too.

The ratios

Standard deviation tells us how volatile the fund`s returns have been in relation to its average. The higher the number, the more volatile is the fund`s returns.

Sharpe ratio, another important performance metric, measures the risk-adjusted returns that the fund generates. In other words, it is the returns generated by the fund over risk-free returns, for a given unit of risk measured by the standard deviation.

Beta is the third important ratio that captures how much a fund`s returns move in relation to a change in its benchmark`s returns. A beta of 1 indicates that the fund moves in tandem with its benchmark, while a beta greater than one indicates that it rises and falls more than the benchmark. A beta of less than one suggests that the fund is less volatile than its benchmark.

Expense ratio is one of the most important measurement tools. It is the percentage of total assets that is paid as management fees and also covers the everyday costs of running a mutual fund. Actively-managed funds typically have higher expense ratio than those that are passively managed, such as index funds or ETFs as in this case it merely involves replicating the index.

All the above ratios must be used for comparing funds with similar mandates across fund houses. For example, if you own two funds that invest in large-cap stocks, it would enable you to see which is riskier and more expensive.

If it is not possible for you to examine factsheets every month, consider doing it at least on a quarterly basis. It would not only help you make sound buying or selling decisions; it is also a lot of fun!