Capitial market investment planning

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One needs to invest to maximize returns on one’s savings and also to be able to generate cash flows for meeting several financial needs of the future. One must, however, invest with knowledge and full care in order to not only protect one’s hard-earned capital but also generate good returns.

What should be investment objectives?
There are normally three objectives: safety, return and liquidity. This means that one would like an investment to be absolutely safe, while it generates handsome returns and provides high liquidity. However, it is difficult to maximize all three objectives simultaneously. Typically, one objective trades-off against another. For example, if one wants high returns, one may have to take some risks, or if one wants high liquidity, one may have to compromise on returns. For people who have a regular income, growth-oriented investments, with some risks, are ideal.Specification of financial goals

Investments are made with certain financial objectives. These objectives should be defined clearly and be measurable in money terms. For example, it is not enough to say, “I want to retire comfortably.” Such an objective should be stated as, “I want to retire with the ability to spend Rs.200,000 annually, adjusted for inflation.”

An investor saves today, to meet certain financial needs tomorrow. Unless the investor is clear about the purpose of saving, his efforts would not result in the desired benefits. An investor should therefore first identify his financial needs. For example, an investor may have one or more of the following financial needs:

To retire at age 55 with an annual income of Rs.300,000. I am now 35 years of age.To completely payoff the housing loan by the time I retire 20 years later.To pay for my five-year-old daughter’s college education that would cost me Rs.150,000 per year for four years. The first step for an investor is to clearly write down the financial needs. The financial needs would be expressed in terms of the amount required and the future date on which required. In the above three examples, we would write (See Table 1):

Every investor should take out time and prepare such a statement of financial goals covering as many requirements as possible. This is the basis on which the financial plan would be prepared. If the financial capability is found to be inadequate to meet all these goals then they have to be prioritized.
The investors’ financial needs depend on the age, stage in the career path, size of the family, needs of the other family members, etc. Some of the needs can be identified with precision while others can only be tentatively determined. There may be unanticipated needs as well for which provisions have to be made. Sometimes financial needs change with investor’s changing circumstances.

In order to prepare a financial plan, these goals have to be stated in clear and determinable terms of age, amounts and time frame. The financial planning process is merely an exercise of allocation of today’s money to meet tomorrow’s needs. The financial plan is not static. It has to be reviewed from time to time to account for the changing circumstances.

Assessing the financial capacity
An investor sets aside some money today to realize the financial goals stated in the financial plan. How much money can be set aside now depends on the present circumstances. This can be understood by understanding the income, assets and liabilities of the individual investor. The balance sheet lists the investor’s assets and liabilities. Hopefully, the assets exceed the liabilities and this excess is the net worth. All assets and liabilities should be valued at the current market value instead of any cost basis. For example, if you own an equity share bought at Rs.1,000 and it is worth Rs.5,000 now, your balance sheet should reflect Rs.5,000. An investor should live within his means. Means is the income. Out of this income, routine expenses are met. The remaining amount is available for savings. An investor should prepare a statement of income and expense. It is called ‘Cash Flow Statement’. The sources of income are salary, dividends, interest, self-employment earnings, etc. After identifying the income, an investor should identify the expenses. Expenses are generally grouped into living expenses, payments already committed and taxes.

The excess of income over expenses in each year is the amount available to save. The investor tries to achieve his financial goals subject to his saving capacity. The Cash Flow Statement is prepared under different scenarios. These are death, disability and retirement.

What is investment planning?
The balance sheet shows what the investor owns and what he owes. The cash flow statement shows the money available for making investments. Together, these two statements tell the investor’s financial circumstances and the saving potential. Financial planning is the process of meeting as many of the investor’s financial needs as possible with his saving potential.

Twelve steps to investing
Before making any investment, you must ensure that you:
1. Obtain written documents explaining the investment.
2. Read and understand such documents.
3. Verify the legitimacy of the investment.
4. Find out the costs and benefits associated with the investment.
5. Assess risk-return profile of the investment.
6. Know the liquidity and safety aspects of the investment.
7. Ascertain if the product is appropriate for your specific goals.
8. Compare the product with other investments opportunities available.
9. Examine if it fits with other investments you are considering or you have already made.
10. Deal only through registered intermediaries.
11. Seek all clarifications about the intermediary and theinvestment.
12. Explore the options available to you should somethinggo wrong and then, if satisfied, make the investment.

Process of investing
As investors, we would all like to beat the market and we would all like to pick ‘great’ investments on instinct. However, while intuition is undoubtedly a part of the process of investing, it is just part of the process. As investors, it is not surprising that we focus so much of our energy and efforts on investment philosophies and strategies and so little on the investment process.

It is far more interesting to read about how Peter Lynch picks stocks and what makes Warren Buffett a valuable investor, than it is to talk about the steps involved in creating a portfolio or in executing trades. Though it does not get sufficient attention, understanding the investment process is critical for every investor for several reasons:

The investment process outlines the steps in creating a portfolio and emphasizes the sequence of actions involved from understanding the investors’ risk preferences to asset allocation and selection to performance evaluation. By emphasizing the sequence, it provides for an orderly way in which an investor can create his or her own portfolio or a portfolio for someone else.

The investment process provides a structure that allows investors to see the source of different investment strategies and philosophies. By doing so, it allows investors to take the hundreds of strategies that they see described in the common press and in investment newsletters and to trace them to their common roots.

The investment process emphasizes the different components that are needed for an investment strategy to be successful and by doing so explains why so many strategies that look good on paper never work for those who use them. Investing well has a secret formula – having the right information, planning and making good choices. “I will tell you how to become rich. Close the doors. Be fearful when others are greedy. Be greedy when others are fearful.” - Warren Buffett

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Capitial market investment planning

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