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speculation as other paper assets, because, after all, there is an underlying physical asset. Only recently, with the rise of a significant paper gold market, the volatility in gold prices has shot up.
we must train ourselves to look at the total portfolio and not the individual assets – and at pre-defined points in time – say once every six months – we should jump in and maintain our asset percentages.
Another difference is in liquidity and volatility. Government bonds – because they’re seen as more reliable – are quite liquid in the secondary market,
and very seldom do you find a situation in which you need money in an emergency and you cannot find a buyer for your government bonds. And as we saw in the preceding section, with increased liquidity comes increased volatility. Corporate bonds are, then, in general less liquid and less volatile than government bonds.
The other measure that affects a bond’s sensitivity to interest rates is the term. With everything else being equal, the bond with the longer term responds more sharply to interest rate changes than the bond with the shorter term. Here, too, focusing solely on interest income is fallacious, though the short-term bond may be paying you more than the long-term one. With the long-term bond, you have the opportunity – albeit at a slightly lower interest income – to avail yourself of the opportunity at higher capital values and much higher profits.
Another way to gain exposure to G-Secs is to buy a mutual fund. Currently, almost every asset management company has a fund that invests in G-Secs. They’re called gilt funds, and they’re available for both long and short-term durations. These can be held in demat accounts, and can be bought and sold in small quantities. Liquidity is assured, and in almost all cases, transactions are immediate. If the convenience of online holding, transacting and outsourcing the management of the investment is important to you, by all means buy into a gilt fund.
I would suggest at least a third of your total bond holdings should be long-term G-Secs, which will give you the lowest interest in the bond market, but also the highest amount of capital protection and capital gain potential.
Like it is with individual success, so it is with a country’s success. Right now, looking into the future, any one among four or five countries could rule this century.
The first of these terms, a fairly commonly used one, is the PE (Price to Earnings) ratio. To calculate this, you will need to know the total revenue of the company in the latest financial year (also called total earnings), and the total number of shares that are publicly available to trade on the exchange for that company. For example, company A has a total earning of 1000 rupees in the year 2014 and there are ten shares of it that are publicly traded on the exchange. If you divide the first by the second, you get the company’s total earnings per share, also called EPS. (On most online
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Now if you divide the price of the company at any given moment by the EPS, you will get the
price to earnings ratio for that company. For example, if a company, ABC, is trading on the BSE today at a price of 500 rupees, and the EPS is, say, 10, the PE ratio at that mom...
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while the PE ratio is a useful starting point to make a quick judgement on whether a company is ‘cheap’ or ‘expensive’, we must keep in mind that the information is about the past, and only an accurate estimation of future earnings can give you the company’s true PE ratio.
obvious. The lower the price to book ratio, the lower the risk that an investor takes by buying into the company.
Another thing to be wary of is what the PB ratio actually tells us. A low PB value tells us that either the market believes the asset value is overstated – that is, the ‘true’ value of the company’s assets are not worth as much as the balance sheet says they are – or that the company is not employing its assets in an optimum manner. If the first is true, if the quality of the assets is in question, then the investor may be better advised to stay clear of the
stock. But if the second is true, then the investor may hope for a better management to come into power and turn things around in the future. But then, nothing may change and things may continue the same way – if not deteriorate.
The theory is that all markets go up and down in cycles, and what goes down must go up and what goes up must go down. Therefore, if you ignore the herd and buy in asset classes that are ignored – or better still, hated – then the gains that you will make could potentially be astronomical.
To be contrarian investors, we must learn to ignore these very basic human fears. A good strategy would be to allow yourself a tiny percentage of your wealth with which you will play this game: 5 per cent is a good number, I think. So with this tiny amount of money, you’re welcome to place your contrarian bets. Then you don’t have to worry about staying power because you have your other 95 per cent invested more conservatively (one hopes) in case the market doesn’t run to your clock. You don’t need to worry about social pressure too much either, because it is, after all, ‘a small amount’. The
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win, you will take some of your returns out of the pile and balance it back to 5 per cent. If you lose, you will either quit the game or ‘borrow’ some from your conservative portfolio. Don’t make a habit of this, though. If you haven’t made money from your first two contrarian investing bets, maybe it’s not for you.
A commonly quoted sentence among passive investors is: ‘Time in the market is more important than timing the market.’ We’d do well to pay heed.
The future value of a stock may change according to future events, but using current information to predict what the ‘fair value’ is fallacious because all the information that you use in your analysis is already accounted for in the price. All the information, in other words, is ‘priced in’. Believers in this hypothesis do not believe in data mining and stock analysis to find ‘cheap’ stocks, because in their book, there is no such thing. Every stock in the market is priced fairly at every point in time, and all the market does is react to events as they come in, faster and more efficiently
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The truth is that from the point of view of the individual investor, markets are essentially efficient. This is because we’re the last people in the world information reaches. By the time we absorb and react to it, the market will have already priced it in. In front of the queue are bankers, big investors, asset management companies and the news makers themselves. So whether or not markets are truly efficient, the lone investor is served well behaving as if they are.
In most cases, in India, the deposit rates are generally a couple of percentage points above the official rate for inflation. But this is before tax. If we incorporate tax into the calculation, the best-case
case scenario for cash assets is that they keep up with inflation – just about.
closely. So money market funds, one could say, combine the best features of bonds and bank deposits to give investors a viable cash alternative.
The first caveat that I would add to this is that whatever your cash holdings are, break it up into four parts. With one part invest in short-term government securities or a fund that invests in short-term gilt. With the second part take out a year’s fixed deposit at a nationalized bank. The third part should go into high-quality money market account. And the fourth could be a year’s fixed deposit in a private bank.
On one sheet, write down all your debt details. Start with the big, easy-to-remember ones and work your way down to the smaller ones. House loans, personal loans, credit card debt, education loans – basically every financial obligation that you intend to keep needs to go into this sheet. Against each item, write down the current outstanding amount, the rate of interest you are being charged, the frequency of your payments, and the payment amount. Add up the total level of debt and store it as a negative number.
Now you will begin classifying each of your investments under one of five headings: real estate, stocks, bonds, cash and gold. Your house will go under real estate. Your fixed and recurring deposits will go under cash. If you don’t have anything under one or more of your assets, either leave it blank or enter zero against it. If you have multiple items under an asset class, make a list. For instance, if you own government bonds,
private corporate bonds and tax-free bonds, you should ideally make a list of three items and record the amount invested in each sub-type. If you own gold in bars, coins and jewellery, you should again make a list and record the amount against each. And so on.
Rebalancing has its critics. Some say that rebalancing is like uprooting the good plants and watering the weeds. But in the world of finance and investing, today’s good plant may become tomorrow’s weed, and today’s weed may become tomorrow’s tree of life. That being the case, I would tend to my weeds as carefully as I would tend to my plants, so that tomorrow, when things turn topsy-turvy, my field will not go to waste.
It’s too easy in such scenarios to succumb to greed. Since in year one, you’ve had a 25 per cent gain in stocks, you tell yourself that you need more in that asset class. ‘If only I had not had so much money in bonds and if I had had it all in stocks,’ you think, ‘my gains would have been double of what I ended up with.’ So you second-guess yourself based on past events and prepare for future events by unloading all bond money into stocks. Only that this year, stocks fall by 15 per cent and bonds go up by the same amount. What has happened to your portfolio value?
In his book, Fail-Safe Investing, investor Harry Browne discusses the Permanent Portfolio at great length. There are four cycles through which economies generally move: prosperity, recession, deflation and inflation.
So if you’re betting on inflation, for example, you would buy more gold and less bonds. If you’re betting on a recession, you would buy more bonds. If you’re betting on the current reign of prosperity to continue, you will buy more stocks. If you think deflation is around the corner, you will allocate more to cash.
