INVESTMENT PLANNING

Learning Outcomes

 Set investment goals

 Assess investment environment and its effects on

investment decisions

 Evaluate investment alternatives

 Discuss the relationship between risk and return

 Formulate a personal investment portfolio

 INVESTMENT PLANNING

Investment planning is the process of matching your financial goals and objectives
with your financial resources. Investment planning is a core component of financial
planning.

Investment planning is a process that begins when one is clear on his financial
goals and objectives. It is designed to match the financial resources to financial
objectives.

Essentially, Investment Planning involves identifying financial goals throughout

life, and prioritizing them. For example, if the goal is to invest for funding vacation next
year, don't choose an investment vehicle that has a three-year lock-in. Instead, choose
an option that matches investment horizon. Investment Planning is important because it
helps to derive the maximum benefit from investments. The success of an investor
depends upon his ability to choose the right investment options. This, in turn, depends on
his requirements, needs and goals. The choice of the best investment options will depend
on personal circumstances as well as general market conditions. For example, a good
investment for a long-term retirement plan may not be a good investment for higher
education expenses. Investments are in stocks, bonds, and other types
of security investments. Indirect financial investments can also be done with the help of
mediators or third parties, such as pension funds, mutual funds, commercial banks, and
insurance companies.

7 Essential Features of an Investment Plan/Program

A good investment plan/program is one which is consistent with the objectives of

the investor, i.e., it should have all the advantages of fruitful investment. The following are
the essential ingredients of a good investment plan/program

Safety of principal
Safety of funds invested is one of the essential ingredients of a good investment
program. Safety of principal signifies protection against any possible loss under the
changing conditions. Safety of principal can be achieved through a careful review of
economic and industrial trends before choosing the type of investment. It is clear that no
one can make a forecast of future economic conditions with utmost precision. To
safeguard against certain errors that may creep in while making an investment decision,
extensive diversification is suggested. The main objective of diversification is the
reduction of risk in the loss of capital and income. A diversified portfolio is less risky than
holding a single portfolio.
Liquidity and Collateral value
A liquid investment is one which can be converted into cash immediately without
monetary loss. Liquid investments help investors meet emergencies. Stocks are easily
marketable only when they provide adequate return through dividends and capital
appreciation. Portfolio of liquid investments enables the investors to raise funds through
the sale of liquid securities or borrowing by offering them as collateral security. The
investor invests in high grade and readily saleable investments in order to ensure their
liquidity and collateral value.

Stable income
Investors invest their funds in such assets that provide stable income. Regularity
of income is consistent with a good investment program. The income should not only be
stable but also adequate as well.

Capital growth
One of the important principles of investment is capital appreciation. A company
flourishes when the industry to which it belongs is sound. So, the investors, by recognizing
the connection between industry growth and capital appreciation should invest in growth
stocks. In short, right issue in the right industry should be bought at the right time.

Tax implications
While planning an investment program, the tax implications related to it must be
seriously considered. In particular, the amount of income an investment provides and the
burden of income tax on that income should be given a serious thought. Investors in small
income brackets intend to maximize the cash returns on their investments and hence they
are hesitant to take excessive risks. On the contrary, investors who are not particular
about cash income do not consider tax implications seriously.

Stability of Purchasing Power

Investment is the employment of funds with the objective of earning income or
capital appreciation. In other words, current funds are sacrificed with the aim of receiving
larger amounts of future funds. So, the investor should consider the purchasing power of
future funds. In order to maintain the stability of purchasing power, the investor should
analyze the expected price level inflation and the possibilities of gains and losses in the
investment available to them.

Legality
The investor should invest only in such assets which are approved by law. Illegal
securities will land the investor in trouble. Apart from being satisfied with the legality of
investment, the investor should be free from management of securities. In case of
investments in unit investment trust funds and mutual funds, the management of funds is
left to the care of a competent body. It will diversify the pooled funds according to the
principles of safety, liquidity and stability.

Investment Environment

The term investment refers to exchange of money wealth into some tangible
wealth. The money wealth here refers to the money (savings) which an investor has and
the term tangible wealth refers to the assets the investor acquires by sacrificing the money
wealth. By investing, an investor commits the present funds to one or more assets to be
held for some time in expectation of some future return in terms of interest or capital gain.
Investment can be defined as commitment of funds that is expected to generate additional
money.

The term Investment Environment encompasses all types of investment

opportunities and the market structure that facilitates buying and selling these
investments. Different types of securities, institutional set-up and the market
intermediaries are the components of investment environment.
FINANCIAL SYSTEM
Composed of the myriad markets and institutions through which funds flow between
lenders and borrowers

FINANCIAL MARKET
Refers to a marketplace, where creation and trading of financial assets, such as shares,
debentures, bonds, derivatives, currencies, etc. take place. It plays a crucial role in allocating
limited resources, in the country's economy.

Money Market
Money Market refers to all institutions and procedures that provide for transactions in
short-term debt instruments that are generally issued by borrowers with good credit ratings

Capital Market
Capital market refers to all institutions and procedures that provide for transactions in long-
term financial instruments
Primary Market
The primary market is where securities are created. It's in this market that firms sell (float)
new stocks and bonds to the public for the first time. An initial public offering, or IPO, is an example
of a primary market.

Secondary Market
A secondary market is a marketplace where already issued securities – both shares and
debt – can be bought and sold by the investors. It is a market where investors buy securities from
other investors, and not from the issuing company.

CAPITAL MARKET

PRIMARY MARKET SECONDARY MARKET

Primary beneficiary is the issuing Primary beneficiary is the
corporation investor/shareholder
Objective is to raise funds Objective is capital appreciation
Includes new securities such as Initial Includes the trading of securities
Public Offerings (IPOs) already offered to the marketplace

FINANCIAL INSTITUTIONS
Intermediaries that channel the savings of individuals, businesses and governments into
loans and investment

Banking institutions – include all financial institutions engaged in the lending of funds obtained
from the public primarily through the receipt of deposits of any kind.

Non-banking institutions – financial institutions other than banks whose principal functions
include lending, investing or placement of funds or evidence of indebtedness or equity deposited
with or otherwise acquired by them, either for their own account or for the account of others
Sources of Investment Information

The three most important sources of information on a company's performance are:

Securities and Exchange Commission (SEC) filings

The Securities and Exchange Commission requires listed companies to
report financial data, insider transactions and other material information in so-
called SEC filings. By knowing how to find and analyze these SEC filings, investors
can ensure that they are well informed and up-to-date on all of the most important
developments.

Corporate Website
Corporate websites can contain a wealth of information about a company, from
financial statements to presentations, and they can be much easier to navigate than many
government agency websites when looking for financial information. The most important
things to look for include:

 Financial Statements
 Company Presentations
Company presentations can provide a great overview of past
performance, as well as projections for the coming quarters or year.
 News/Press Releases
Company news and press releases can contain a wealth of information
about day-to-day operations and financial performance.
 Contact Information
Investor contacts, such as Investor Relations Officers, can be a great
resource for investors looking for something they can't find elsewhere.

Analyst Reports
Securities analysts can be a great source of information for investors. While sell-
side analysts may be biased at times, they still offer some valuable information in a single
location. Buy-side analysts are an even better source of information since they are
typically not as biased, but their research usually isn't as widely available. Analyst reports
can be found in places including:

 Stock Brokers
Many stockbrokers offer access to certain analyst reports for their clients
 Companies
Some companies offer analyst research to potential investors, either
through their website or by e-mail or phone request.
  Websites/Services
Some news agencies write about analyst research, while services like
Yahoo Finance, Investopedia, and others provide research synopsis and financial
literacy information to readers.

Risk and Return

The basic idea of investing is that money is into something and, if all goes well,
end up with more money than what was invested. The return on investment is a simple
way of looking at this process of gain, calculated using a simple formula:
ROI = (Current Value of Investment – Cost of Investment)
Cost of Investment

The useful thing about this formula is that it’s easy to apply to any investment type.
Because it can produce negative numbers it can also measure loss on the same scale.
By comparing ROIs, one can work out which of his investments are most profitable.

While return can be understood as one simple number, risk is a bit more
complicated. There are two main ways that it can happen.

Firstly, individual assets can be voided completely: if a company goes

into liquidation, its shares may become worthless. If a country ceases to exist, bonds
issued by its government will often become worthless.

Secondly, the return on investment that the assets generate may not be sufficient
to keep pace with inflation. In this case, ROI will still go up but the money will be worth
less in real terms than the money had originally.

It’s also worth noting that if high fees are paid in connection with some of the assets
– for instance, towards the management of a mutual fund – then one can still end up
losing money even if there is a positive ROI.

As a rule, investments that entail more risk offer a higher ROI and vice versa. Low-
risk investments give a good chance of making a profit but that profit is unlikely to be very
big in return for the outlay. High-risk investments offer much bigger profits but there’s a
higher chance of losing the money.

As a rule, different types of assets carry different levels of risk. Although individual
assets vary a great deal, this can be used as a starting point in finding the right assets.
 Fixed interest assets such as government bonds are low risk.

Property investment is medium risk but there are things that can be done to
moderate risk further, such as carrying out professional renovations on properties.

Shares are generally classed as high risk, however, in practice the degree of risk
can vary enormously. Shares in large, well-established companies are comparatively low
risk. Shares in start-ups are high risk but can deliver the highest returns if one gets lucky.

Diversification

Diversification is a technique of allocating portfolio or capital to a mix of different

investments. The ultimate goal of the diversification is to reduce the volatility of the
portfolio by offsetting the losses of one asset class by the gains of another asset class. A
phrase commonly associated with diversification:
“Do not put all your eggs in one basket“. Having eggs in multiple baskets mitigates risk
as if one basket breaks, not all eggs are lost. The key advantages of diversification
include:

 Minimizing risk of loss

If one investment performs poorly over a certain period, other investments
may perform better over that same period, reducing the potential losses of the
investment portfolio from concentrating all capital under one type of investment.
 Preserving capital
Not all investors are in the accumulation phase of life; some who are close
to retirement have goals oriented towards preservation of capital, and
diversification can help protect savings.
 Generating returns
Sometimes investments don’t always perform as expected, by diversifying
there’s no relying upon one source for income.
Diversification done improperly, including over diversification, can be very harmful.

Here are some investment diversification disadvantages:

 Reduces Quality
There are only so many quality companies and even less that are priced at
levels that provide a margin of safety. The more stocks put into the portfolio the
less concentrated the portfolio will be in the best opportunities.
  Too Complicated
Many investors include so many assets in their portfolio they don’t really
understand what’s in them. Diversification in investing is important, but the portfolio
must be kept simple enough to stay on top of the investments.
 Indexing
If there are too many assets in the portfolio it essentially becomes an index
fund. Don’t waste transaction fees on purchasing numerous assets that morph
into an index fund. The more stocks owned the more correlated the portfolio will
be to market returns. While passive management or indexing might work in bull
markets it does not work well in flat or bear markets.
 Market Risk
Before buying an index fund be sure to understand the mathematics of
how portfolio volatility lowers portfolio performance. Few investors ever achieve
even close to “average” returns because of volatility caused by market risk.
 Below Average Returns
Indexing and over diversification are disadvantages of diversification
because quality suffers when one owns inferior investments along with good
investments. Below average returns result from transaction fees or high mutual
fund fees. In addition to portfolio volatility lowering returns, many investors let their
emotions cause them to buy high and sell low.
 Lack of Focus or Attention to the Portfolio
If someone else is managing the portfolio one probably doesn’t pay as
much attention to it, or he waits until it’s too late.

What makes a diversified portfolio?

To diversify the portfolio, one needs to spread his capital across different asset
classes to reduce overall investment risk. These should include a mix of growth and
defensive assets:

 Growth assets
Include investments such as shares or property and generally provide
longer term capital gains, but typically have a higher level of risk than defensive
assets.
 Defensive assets
Include investments such as cash or fixed interest and generally provide a
lower return over the long term, but also generally a lower level of volatility and risk
than growth assets.
 A diversified portfolio means spreading risk by investing:
 Across different asset classes such as cash, fixed interest, property, etc.
 Within asset classes such as purchasing shares across different industry sectors
 Across different fund managers if investing in managed funds.

Diversification is primarily used to eliminate or smooth unsystematic

risk. Unsystematic risk is a firm-specific risk that affects only one company or a small
group of companies. Therefore, when the portfolio is well-diversified, the investments with
a strong performance compensate the negative results from poorly performing
investments.

However, diversification does not usually affect the systematic risk which is the risk
associated with the collapse or failure of a company, industry, financial institution or an
entire economy because the risk is a market risk affecting all companies in the market.