“Time is Money.” This proverb holds very true in the matters of investing.

Long-term investments work like hidden treasures when you are least expecting to find any of it. Compounding your savings is just one of the benefits of long-term investing wherein the more time you stay invested for, the greater are the returns. Albert Einstein once said, “Compound interest is the eighth wonder of the world. He, who understands it, earns it. He, who doesn’t, pays it.” Let your money work as hard as you and grow with you.

A simple example can be of a young working professional who has just started investing at the age of 25. By the time she is 65, her wealth would have multiplied several times, despite inflation and fluctuations in the stock market. That is the effect of the simple policy of compounding.

On the contrary, if one starts investing at the age of 35, the returns are comparatively lesser by the time she is 65 years old. It is only because the more interest one reinvests, more the final wealth is. This concept of reinvesting or earning interest on interest is what compounding is all about.

Though there are ample types of investment vehicles, long-term investment is one tried and tested formula that smartly turns the ‘returns table’ on your side as it needs much less time to create, monitor and evaluate than short-term investing. Here are some compelling reasons why staying invested is better than going on and off the market:

Easy Methodology
Any Tom, Dick and Harry can invest money for a long term. It doesn’t take a financial mogul to decide on a long-term financial instrument. You can leave your savings to grow and forget about them. Short-term trading, on the other, will depend on the market growth, learning new trading styles, working on different investing options, studying charts and graphs. Phew! The list is endless and draining. Guess you would agree that getting better money value with a bit of patience is any day better than losing sleep thinking about your portfolio losses or gains with the market movements.

Who doesn’t love a little lesser tax?
Active trading also makes you an active tax-payer. Based on the investment avenue and time horizon, the tax liability varies. Mutual funds serve as a tax efficient investment avenue. Like in case of other investment avenues in mutual funds also, if you invest for a shorter time horizon, you attract short term capital gains tax on your investment as per your tax bracket. While long term capital gains is tax free in case of equity mutual funds and in case of debt schemes you are eligible for indexation benefits. Mutual funds also offer ELSS which are eligible for tax exemption under section 80/C of the Income tax act. Thus staying invested for a long term has its perks.

The Compounding Effect!
Buying stocks or investing in mutual fund for a long term helps you enjoy compounding – reinvesting the interest you have already earned. Compound interest, that calculates your returns on your principal, will grow your investment balance helping you earn more interest income. The effect of compounding depends on three factors viz. investment horizon, rate of return and compounding frequency. The longer the investment horizon, more the interest on interest earned. Similarly, higher the rate of return, more wealth gets accumulated over time. Compounding frequency is the interval at which the interest multiplies. Compounding can be done on daily, monthly, quarterly, half yearly or annual basis. Shorter the interval of compounding, greater its impact.

Sorting investment mistakes with ease
Albeit a long-term investment will help you avoid those mistakes that can happen with price fluctuations and jumping in and out of the market based on market performances; any investment mistake can only be recovered with time. So, a long term investment can help you recover a bad time with the stock market by staying invested for a successive good market time. You can also tweak in and invest better over the years to make it address all your financial goals. Now the choice is yours – will you now choose to be a proactive long-term investor or a reactive short-term trader?

Quite often we come across people chasing the best performing asset class of the moment in the quest to earn superior returns with the least or, in some cases, no consideration for risks involved. If the outcome is positive, they wish they had invested everything they had back then. Such behaviour is not uncommon and stems from the fact that most people are oblivious to the concept of risk.

For many years, property and gold were considered as safe avenues for investment and one would get laughed at if she said that their prices could come down some day. Apart from price volatility, there are other inherent risks in these investments which people fail to consider. Here is a look at some such risks that apply to most asset classes.

Market risk: In simple words, this is the risk that the principal invested may not return its full value when you sell the asset. This applies to all investments. Just in case someone thought that investing in the so called safe havens such as gold and bonds would be devoid of market risks, they are mistaken.

Liquidity risk: This is the risk that the asset cannot be sold at the desired time or market price if cash is needed at a short notice. While there is a high level of liquidity risk with property, it is lesser in gold.

Credit risk: This are relevant to bond investments and arises when the borrower defaults or delays on payment of interest or principal. Investors tend to ignore the financial health of the borrower and go for high yielding investments.

Reinvestment risk: Investments in bonds carry reinvestment risk. This is because interest rates prevailing on the coupon payment or maturity dates may differ from the original coupon of the bond.

Risk of unpredictable returns: Standard deviation is used as a measure of risk of unpredictable returns. It measures the movement away from the average in a data set. For instance, for headline equity indices, the standard deviation based on their annual returns falls in the range of 35-37%, for mid- and small-cap indices it is 40-45%, for the gold price index it is about 18%, for the government securities index it is 6.5-7.5%, for bond indices it is 2-4%, for the liquid index it is up to 2%, and for the one-year treasury bill index it is about 3%.

So, if the average annual return on bonds is 7%, a standard deviation of 4% would mean that most of the times the returns would range between 7%-plus and negative 4%, i.e., between 3% and 11%. While making investment decisions, savvy investors prefer to consider risk-adjusted returns, which take into account standard deviation in returns. The past financial market turmoil, especially in 2008, has caused great harm. But it has also made us better informed and increased our awareness towards risk. With increased thrust on financial inclusion in India, we would hopefully see increased awareness and change in investor behaviour towards risks as well.

In the financial world, the phrase ‘risk-free rate’ refers to yields on treasury bills. But are they really risk-free? All investing involves taking some form of risk, even if it is not that apparent. Talking about risks which are not apparent but are present, brings forth the classic example of deposits placed with various institutions which earn a fixed rate of interest. Technically speaking, these offer predictable returns (negligible to zero standard deviation), which may also be the best risk-adjusted returns. But there are other risks to consider. No, I am not talking about credit risk, reinvestment risk or even illiquidity risk, which are very much there and which most text books will teach you and prepare you for. I am pointing towards the risk of loss of purchasing power, either due to inflation or due to taxes. Are investors actually earning real returns after taking inflation into consideration? This is the risk of playing too safe or being too conservative. I am not suggesting that one should take more risk to get proportionately higher returns. But the least one could do is to follow a proper asset allocation depending on her investment horizon, goal(s) and risk appetite. Generally, a financial adviser helps one with a suitable asset allocation depending on individual inputs shared with her.

Let’s take an example to understand this. If you are investing for retirement, which is some years away, then keeping your savings in low-yield investments could stunt the long-term growth of your savings pool. You would then find it difficult to maintain your standard of living after retirement. Conversely, if you’re nearing or have already retired and are counting on withdrawals from your savings pool to pay for your living expenses, a meagre return on your savings would force you to keep those withdrawals at a modest level—which you would then increase by the inflation rate each year to maintain purchasing power. Pull out more, and you would run a high risk of running out of money early in retirement.

The bottom line is that you can’t eliminate all risk when investing, and the more you focus on avoiding just one peril, the more vulnerable you’ll be to others. By diversifying smartly, you should be able to protect yourself adequately against a variety of risks, and lower the chances that any single threat will do your portfolio in.

There’s no such thing as a risk-free return, and it’s not a right-now problem based on the level of the market or the low returns on deposits, but it’s about how risk works. The same rule applies to stock picking as well. When a company’s stock is available at a certain price, one needs to ascertain whether there are risks that are not apparent but are present and which need to be considered to arrive at the true value of that stock. These could be the risk of a faulty business model, weak management or corporate governance structure, weak financials, and so on, all of which impact the sustainability of the company’s earnings. If one considers all the risks and then prices the stock accordingly, the outcome of the investment is likely to be a better risk-adjusted one.

Kevin 29 years, a client servicing executive working with an Ad agency has been living in Delhi for the last 8 years. His dreams have come true as he bought a car 2 years back and is now planning to buy an apartment next year using the bonus that he will be getting. He and his wife go for one holiday outside India every year coupled with 2-3 domestic holidays. He had taken a personal loan for his wedding.

Majority of his monthly earnings go towards monthly living expenses, EMI for car loan& personal loan, credit card bills and occasional partying. For the purpose of tax savings, he has bought life insurance policies and a health insurance plan. The only form of savings for the specific purpose of retirement is done through EPF. But while switching jobs, he has withdrawn the EPF accumulated during the previous stint to pay up for the down payment of the car and rental advance for the house he is living in. He chooses to withdraw from EPF, citing the reason as “I have a long way to go for retirement, let me utilize this fund for something more important now”.

This is what most of us choose to do. PF corpus, which is meant for retirement is withdrawn for various reasons like buying a primary house, clearing up credit card/ personal loan dues, foreign travel, buying car etc. The strong belief is, “I’m young and I have a long way to go for retirement. Let me plan for it when I start earning more”

This brings us to the most important question, “When is the right time to start planning for retirement?”

While we keep postponing the plan for retirement, what we tend to ignore is inflation. As discussed in the previous topic, the average inflation(WPI) over the last 35 years in India has been 7.57%. But our lifestyle inflation that includes education, entertainment, travel, electronic gadgets etc. is believed to be far higher. Keeping this in mind, it is wise for us to infer that when we retire, we will need a much bigger corpus to sustain the same standard of living and yet cope with inflation.

If you are spending Rs. 30,000/- when you are 30 years old……..when you turn 60, you would need Rs. 172,000/- to maintain the same standard of living @ 6% inflation.

To manage a retirement life of 25 years with out any income, you would approximately need Rs 3.72 crs when you turn 60 years.

Impact of Inflation on our future expenditure at the time of retirement (Amount in INR)
	Person Aged 30yrs	Person Aged 40yrs	Person Aged 50yrs
Current Monthly Expenses	30,000	45,000	60,000
Expenses at Retirement age (60 years)	1,72,000	1,45,000&	1,07,000

(Inflation rate assumed @ 6% p.a.)

Illustration disclaimer: The above example is only for illustration purposes & shall not be construed as indicative yields/returns of any of the Schemes of Canara Robeco Mutual Fund. Once an individual retires, the corpus accumulated for the purpose of retirement needs to be invested in a place where it generates regular income on a monthly basis. The objective of such an investment corpus is very clear – regular income generation and capital protection. Withdrawal for 25 years starting at the age of 60 years (withdrawal for 300 months, Amount in INR)

	Person Aged 30yrs	Person Aged 40yrs	Person Aged 50yrs
Monthly Expenses at Retirement age (60)	1,72,000	1,45,000	1,07,000
Post Retirement investments return	Investment option yielding 9% returns p.a.
Inflation	Inflation rate assumed 6% p.a.
Corpus Required at Retirement	Rs. 3.72 Cr	Rs. 3.12 Cr	Rs. 2.32 Cr

Illustration disclaimer: The above example is only for illustration purposes & shall not be construed as indicative yields/returns of any of the Schemes of Canara Robeco Mutual Fund. For an individual who is 50 years old, target to accumulate 2.32 Crores in 10 years is quite an uphill task, if he doesn’t have existing corpus already built up. For a person who is 30 years old, building a corpus of 3.72 crores over 30 years shouldn’t be too difficult provided he is a disciplined investor and invests regularly.

	Person Aged 30yrs	Person Aged 40yrs	Person Aged 50yrs
Corpus Required at Retirement	Rs. 3.72 Cr	Rs. 2.08 Cr	Rs. 1.16 Cr
Existing Corpus	3,00,000	5,00,000	7,00,000
SIP required to accumulate the corpus (returns @ 12%)	9,262	17,537	42,546

llustration disclaimer: The above example is only for illustration purposes & shall not be construed as indicative yields/returns of any of the Schemes of Canara Robeco Mutual Fund. The day first salary/income is earned by an individual is the day one should start saving up for retirement. The corpus earmarked for retirement (likes of PF, PPF etc.) shouldn’t be withdrawn prematurely and should be utilized only for the purpose of building a retirement corpus.

We always seek excitement and action in what we do, so is the case with investments. Every time investments generate decent amount of returns due to bull run in the stock market, we tend to think, “Should I start booking the profit and exit from the market”? We have also seen instances where some of the investors redeem the investments when the market crashes to cut the losses. So, what is the right time to redeem the investments?

Before an investor arrives at the answer for this question, it’s wise to answer the below mentioned questions:

1. Reason for withdrawal?

Ideally one should always map the investments to the specific financial goal (Retirement, Children’s higher education, foreign travel etc). Once the investments are mapped, they should be held till the financial goals are met.

For instance, generally the contribution towards Employee Provident Fund (EPF) is earmarked for the purpose of retirement. But some of us tend to redeem the EPF corpus while switching jobs. The reason for redemption could be anything (foreign travel, clearing credit card dues, down payment towards housing loan etc) but the EPF corpus is meant for the purpose retirement which shouldn’t be withdrawn earlier or utilized for any other purpose.

The funds invested or the SIP which is invested in should ideally continue till the goals are met.

2. Should I time the market?

In the earlier discussion, we have established the fact that in the long run timing the market doesn’t necessarily help. What matters is <b>“time in the market”</b>. So redeeming the funds to time the market is also not recommended.

At times we feel compelled to act when stock and commodity markets are highly volatile. As investors, we may want to book profits when markets have appreciated and invest more when stock prices have fallen. In such scenarios, one could look at the concept of tactical asset allocation strategy.

There is a school of thought which believes in following Price Earnings (P/E) ratio to take decision on asset allocation. Higher P/E ratio indicates that the stock market is expensive and there is probable market correction round the corner. A lower P/E ratio indicates an opportunity for an investor to invest in equity.

The lower and higher Nifty P/E levels

	Date	Nifty P/E	Date	Nifty P/E
1	27-Oct-08	10.68	11-Feb-00	28.47
2	12-May-03	10.84	8-Jan-08	28.29
3	1-Jan-99	11.62	12-Dec-07	27.69
4	24-Jun-04	11.82	13-Oct-10	25.91
5	13-Jan-09	12.16	23-Dec-99	24.22

Source: www.nseindia.com

A 30 year old investor looking to accumulate Corpus for the purpose of retirement has invested in the asset allocation ratio of 70:30 in Equity & Debt. If the current nifty P/E is 10.68, he decides to redeem 10% from debt and get into equity to take advantage of the lower P/E levels. At P/E levels of 28, the investor might look at reducing the equity exposure by 10%. This process of rebalancing is done to take advantage of market volatility.

But it is not important to time the market while looking at long term financial goals.

Note: It is not necessary that all the low P/E stocks are good investment avenues. The most important factor to be looked at is financial health of the company.

3. Should I look for better a performing fund/Investment option?

Investments are not “Fill it, shut it & forget it”. Even though equity mutual fund investments should be held for long term, one has to review the performance of the funds regularly with the financial advisor. Based on the recommendation from the advisor, one can move out of the non-performing fundand move into other funds that meet the objective.

4. How much time left in reaching the financial goal?

Equity investments are always perceived to be risky. Investors are generally worried that the stock market might crash just before they have to redeem the money from equity funds that were meant for a financial goal.

In such circumstances, an investor could look at moving out of equity investments in a phased manner and get into Debt or debt oriented hybrid funds which are considered to be relatively less risky. A 55 year old individual has been accumulating money towards retirement corpus for the last 25 years. She wishes to retire by 58 years which is three years from now. 33% (or 20% of equity over 5 years) of Equity investments could be switched out of the fund at the beginning of every year starting from today and switched into a Monthly Income Plan (MIP) or Short Term Income Plan kind of a debt oriented product. While we tell investors to enter equity markets systematically, the same logic can be applied while exiting as well. Phased exit from equity in a systematic way would help the investor in insulating from sudden shocks of equity markets.

So finally, to answer to the main question as to when is the right time to redeem money, ideally one should look at redeeming funds only when the financial goals are to be achieved. The funds invested in core portfolio are held till the financial goals are met but regular review is done to assess the performance. The outcome of assessment could be to decide whether to hold, buy or sell the funds. If an investor wants to take advantage of changing market dynamics, satellite portfolio could be used for changing the type of funds to suit the changing market conditions.

What is BEER Ratio?

The Bond Equity Earnings Yields Ratio (BEER) is a metric used to evaluate the relationship between bond yields and earnings yield in the stock market. The ratio has two parts- the benchmark bond yield in the numerator and the earnings yield of a stock benchmark in the denominator. A comparison of the two can be used as a form of indicator on when to buy the stocks as it measures the relative attractiveness of equities over bonds. It is also known as the Gilt-Equity Yield Ratio (GEYR).

Formula:
BEER=Bond Yield ÷ Earnings Yield

If the above formula gives a value Above 1; it indicates the stock market is said to be overvalued; If the value is Less than 1, it indicates that the stock market is undervalued. Usually, the ratio is calculated by comparing the yield of a Government Bond and the current Earnings Yield of an Index e.g. Nifty50 or BSE Sensex. (Note: Earnings yield an inverse of the Price-to-Earnings (P/E) ratio).

Interpretation of BEER:

• BEER= 1; indicate equal levels of perceived risk in the bond market and the stock market.
• BEER< 1; indicates that equities are undervalued and could be considered a good time to add allocation to equities.
• BEER> 1; means that equities is overvalued as compared to fixed income and the allocation can be considered to be lowered in equities.

 

Source: Bloomberg; Note: BEER ratio compares 10-year Treasury bond yield to the earnings yield of the Nifty index; a drop in its value denotes lower equity valuations vis-a-vis bond market

 

E.g. During events like Demonetisation and Taper Tantrum 2012-13, BEER slipped to 1.1 level. 

The earnings yield has been higher than bond yields recently for the first time since 2009. In previous instances, the same was witnessed during FY 2002-03 and FY 2008-09 which was followed by outsized returns in both the cases.

Limitations of BEER:
BEER ratio appears to have zero predictive value, based on research that was carried out on historical yields in the Treasury and Stock markets. Therefore, it cannot be used to predict any future trends. Besides, creating a correlation between stocks and bonds is said to be flawed as both investments are different in several ways:

• Government bonds are contractually guaranteed to pay back the principal whereas stocks promise nothing, and it is not considered while calculating the ratio and further interpretation from the same.
• A stock’s earnings and dividends are unpredictable, and its value is not guaranteed unlike bonds.

 

However, the significance of BEER cannot be undermined, especially in a scenario as this where the valuation of equity stocks is low, and the government bond yields are increasing.

The core feature of a fixed income  instrument is such that they offer to pay a stated rate of interest periodically and return the principal at the end of a defined period. There are risks involved with such investments, especially the risk that the periodic repayment may not come in as promised. Investments in debt funds carry various types of risk such as  interest rate risk or inflation risk, etc. but the key risk which needs be considered before investing in debt funds is credit risk.

Credit risk is the risk that the issuer will not pay the coupon income and/or the maturity proceeds on the specified dates. This could also lead to capital erosion of the scheme’s portfolio owing to a downgrade in the credit rating. The credit rating of a debt instrument indicates the credit risk that it carries. Credit rating is the measure of the credit worthiness, of the issuer to meet the interest and principal repayment obligation. A drop in the credit quality leads to a drop in liquidity.

Credit ratings are assigned by specified agencies like CRISIL, ICRA and other agencies based on multiple factors and assigned a symbol (See: Symbol and Definition below). These symbols indicate the degree of safety with respect to timely servicing of financial obligations from low to high credit. The portfolio of a debt fund scheme indicates the combined credit quality of its underlying holdings. For instance, investments in G-Secs carry no credit risk.

Investors need to note that the credit rating of an instrument may change over time, depending on improving or worsening financial strength of the issuer. So, if the credit rating of an instrument gets downgraded, its price will fall and if the rating is upgraded, its price will go up. The credit risk fund category adopts credit rating as a strategy to invest. These funds seek to maximise portfolio yield by primarily investing in below AA+ rated corporate bonds.

The premise being if the bond’s credit rating improves over time, it will make its price go up. Likewise, funds adopting the accrual strategy aim to generate returns by managing credit risk (to earn higher yield) while minimizing interest rate risk. Investing in a fund with a portfolio that invests in government securities, quasi-government securities such as PSU bonds, bank issuances and highly rated private sector companies of good parentage give the comfort of quality. A portfolio with high-quality papers is also easily liquidated when the need arises.

Credit rating is dynamic and can change over a period of time. Rating agencies evaluate the performance of companies and the risk assessment is done at periodic intervals. Investors should check the credit rating of underlying investments of a debt fund portfolio.

Symbol and Definition

Rating Symbol	Rating Definition
AAA	Instruments with this rating are considered to have the highest degree of safety regarding timely servicing of financial obligations. Such instruments carry lowest credit risk.
AA	Instruments with this rating are considered to have high degree of safety regarding timely servicing of financial obligations. Such instruments carry very low credit risk.
A	Instruments with this rating are considered to have adequate degree of safety regarding timely servicing of financial obligations. Such instruments carry low credit risk.
BBB	Instruments with this rating are considered to have moderate degree of safety regarding timely servicing of financial obligations. Such instruments carry moderate credit risk.
BB	Instruments with this rating are considered to have moderate risk of default regarding timely servicing of financial obligations.
B	Instruments with this rating are considered to have high risk of default regarding timely servicing of financial obligations.
C	Instruments with this rating are considered to have very high risk of default regarding timely servicing of financial obligations.
D	Instruments with this rating are in default or are expected to be in default soon.

(“+” (plus) or “-“(minus) can be used with the rating symbols for the categories AA to C. The modifiers reflect the comparative standing within the category.

We all have attended weddings and tasted buffets; the variety of cuisines offered just makes our mouths water. But not everyone likes everything, we all have our favorites. Kids might prefer desserts while health-conscious people prefer soups & salads and we all have some cheese lovers amongst us who would like munching on pizzas & pasta. We all have preferences and based on our taste buds we choose the dish we want to eat. The scenario for Mutual Funds is similar. There are various mutual fund products offered in the market and the selection of funds should be done judiciously. Following are few parameters one should take into consideration before selecting the best-suited fund:

1. Ascertain the goal for investing:
   Selection of the fund to be invested in should be done based on one’s objective for investing. If the goal is to save tax then one should opt for ELSS funds. If one is looking for an avenue to park surplus funds for a short term period, one may opt for Liquid Funds.
2. Risk level of a scheme:
   Different schemes have different risks attached to it. An aggressive investor can look at equity mutual funds whereas conservative investors who are looking for stable income may take debt funds into consideration. The risk level of a scheme can be gauged by looking at the riskometers which are mentioned along the scheme names.
3. Investment horizon:
   Knowing one’s time horizon is extremely important when it comes to choosing the type of Mutual Fund one wants to invest in. Mutual funds offer various funds catering to different needs of an investor. An investor can invest in Liquid, ultra short term or short term fund category for a tenure of less than 1 year. While investment in equity funds viz. Equity Diversified funds, ELSS, Sectoral or Thematic funds etc. should be ideally be made for a longer tenure i.e. more than 3 years.
4. Past Performance:
   A scheme’s past performance can be understood by looking at NAV movement and comparing the scheme returns with its benchmark. An investor can also find the scheme’s return vis-à-vis its benchmark in mutual fund’s factsheet
5. Asset Allocation:
   Investment objective and the portfolio of a scheme lay down the securities or instruments where the scheme has invested in. By looking at scheme asset allocation, the scheme’s asset allocation, an investor can understand the investment theme the fund is following. For e.g. If the scheme is investing across sectors/instruments then the portfolio is more diversified thus the risk is spread out.
6. Rating Allocation:
   Credit risk of a debt scheme can be deduced by the credit rating of instruments in which the scheme has invested. For e.g. If the scheme invests 70-80% in AAA or A1+ papers, it indicates that majority of the portfolio is invested in instruments whose probability of default is very low.
7. Top Holdings:
   The portfolio of a scheme as on the last trading day of the month is available on the fund fact sheet or on Mutual Funds website. One can understand which securities the scheme is investing in & thus identify what drives the fund’s performance through this data.

Congratulations on your newly acquired “bundle of joy” and welcome to parenthood. Or perhaps you already are a parent but the arrival of the new one has got you thinking about their future, their education. Giving your child a good education can be one of the most valuable gifts you can ever provide but it can also be one of the most expensive. Plan for the future to avoid scrambling around at the last minute to find ways to pay for your loved ones’ education, or worse, compromising on the quality of education just because you cannot afford it.

Let’s look at the cost of an M.B.A. course in India from a relatively good university. This currently costs at least Rs. 5 lacs per year. That’s 10 lacs for the course and this price will only increase over time. If you hope to send your child or children abroad to study, the expense will be much greater. For example, an undergraduate university in the U.S.A. can cost from USD 30,000 (INR 18 lacs) upwards per annum and most of them are 4 year courses. Ouch!

Let’s look at some projected expenses within India:

Source: Engineering and MBBS fees are calculated as average fees of top colleges according to TOI, 11 January 2013. MBA fees are calculated as average fees of top colleges according to Business Standard, 5 February 2013. The inflation rate has been taken as 6% per annum.

Clearly, for most of us, these are big chunks of money and seem like intimidating financial goals to achieve. Undoubtedly, your salary will increase over the years, but so will your expenses. Your money should work as hard as you do to help you reach your financial goals. Now coming back to funding your child’s education..

The 2 main avenues for investing are debt and equity. Debt is generally considered to be a safe investment. The flip side is that the returns tend to be limited, unlike equity investments, which have historically provided superior returns when people remain invested over an extended period of time i.e. over years as opposed to months.

History has shown that for patient, long term investors, equity is the preferred option since it is likely to provide much better returns than debt. Within the equity category, unless you are an expert investor and knowledgeable about the potential vagaries of the stock market, your best bet is investing via equity mutual funds since these are managed by professionals.

3 parameters you should look at when deciding where to park your savings are:

1) Investment horizon – how long can the money remain invested without needing to withdraw all or even part of it? The longer your investment horizon, i.e. more than 3 or even 5 years, the better it might be, since such extended periods often enable you to withstand the risks, of investing in equities. For horizons less than 3 years, an investment in debt should be considered as this is generally less risky than equities.

2) The impact of inflation – investments in debt such as, fixed deposits or other bonds, often provide minimal (low, single digit) returns when we take into account inflation. For example, if inflation is at 7% and you are earning 10% in a fixed deposit, you are effectively only earning a 3% return.

3) The power of compounding. If you are able to plan years in advance and can put aside funds on a regular basis (see SIP), you will benefit greatly from compounding.

For example, if you expect that one child’s college fees to cost you Rs. 20 lacs, here’s what you need to do to ensure you have that liquidity when required:

If you start investing when your child is 3 years old, you only need to invest around Rs. 3,000 per month, to reach (and in this instance, actually exceed) your targeted amount. If you start when your child is 13, and you more than double your monthly installment (from Rs. 3,000 to Rs. 6,750) the amount you will have totally invested will be the same (almost Rs. 6.5 lacs in both cases).

However the expected value at age 21 is only Rs. 10.8 lacs as compared to Rs. 22.7 lacs if you had started investing earlier.

The above table is an example only for illustration purposes, purely to explain the effect of compounding on investments over a long term. The growth rate of the investment is assumed at 12%. Please note the growth rate mentioned above is purely for illustration purposes only

So, one should start early and invest regularly. As they say “better late than never”. Once you have set-up your monthly investment plan, you can enjoy your newly acquired “bundle of joy”.

While evaluating an investment option, we generally tend to see the returns generated by the investment option and the risk involved in investing as two separate things. There is a way in which both returns and risks involved in a particular investment can be clubbed to arrive at a concept called “Risk Adjusted Returns”.

Risk adjusted returns are the excess returns generated by fund for the every unit of risk associated with it.

Broadly we could use Sharpe ratio and Treynor ratio to measure the risk adjusted returns.

1. Sharpe Ratio:

In arriving at the risk adjusted returns, Sharpe ratio considers the returns generated by the fund and the risk free rate (Government security/Treasure bills rates are considered as risk free) to arrive at the excess rate.

If the fund/portfolio returns are 18% and the risk free rate is 8%, the excess return generated by the fund is 10%. The fund has generated 10% over and above the risk free rate, which is nothing but the “Risk premium” of the fund. Standard deviation is used to assess how much risk is involved in generating the excess returns. If the standard deviation of the fund is 4, then the Sharpe ratio of the fund is 2.50.

Fund	Sharpe Ratio	Standard Deviation
Fund B	0.64	16.86
Fund D	0.38	17.98
Fund F	0.68	14.84
Fund H	0.27	18.74
Fund R	0.39	20.02
Fund T	0.28	16.75
Fund U	0.54	14.13

When comparing the Sharpe ratio, higher the ratios better the fund. In the above mentioned illustration, Fund F and B have the higher Sharpe ratio in the fund category, which are better funds. The reason for better Sharpe ratio is portfolio risk (Standard Deviation) of the fund is among the lowest.

2. Treynor Ratio:

Both Sharpe and Treynor ratio measures risk adjusted return. Treynor ratio uses mutual fund/portfolio beta while calculating risk adjusted returns, where as Sharpe ratio uses Standard deviation.

The interpretation of the ratio would remain the same;what is the risk taken, to generate the excess returns.A fund with higher the ratio in the peer group is considered to be better fund in the category.

Jensen’s Alpha:
Alpha is another risk adjusted returns measurement tool which measures the fund manager’s outperformance. “Alpha gives the excess returns over the expected rate of return”. The objective of the investment is to generate optimum returns with least possible risk. A fund/portfolio with higher Alpha among its peers would be the fund which generates higher return with least risk.

Fund Alpha = Fund’s Actual returns – Expected rate of returns

Fund	Alpha
Fund B	8.91
Fund D	4.77
Fund F	8.41
Fund H	2.95
Fund R	5.49
Fund T	2.68
Fund U	5.93

As per the illustration given above, Fund B and Fund F have higher Alpha in the category. They generate higher returns for the limited risk taken by the fund. Both of these funds could be ideal choices for an investor to have in his portfolio.

Expected rate of returns is arrived at by using the Capital Asset Pricing Model (CAPM). The CAPM uses market risk i.e., Fund Beta to compute the expected rate of returns (ER).

ER =Rf+β*(Rm-Rf)
ER = Expected rate of returns
Rf= Risk free rate
Β = Fund/portfolio beta
Rm= Marketreturns

The above table is for illustration purpose only & shall not be construed as indicative yields/returns of any of the Schemes of Canara Robeco Mutual Fund. Past performance may or may not be sustained in the future.

You are in a stage of life wherein it is understandable that you are unsure whether you should save or invest. The answer is probably that you should do both.

It really depends on your current financial situation. The choice between saving and investing depends on a few factors. For instance, if you have any financial liabilities, such as a student loan, you should focus on paying these off before you start saving or investing for any other financial goal as the interest you pay on these loans is generally higher than the interest you would earn on your savings.

As you have just started to earn and in case you have no loans that need to be paid off, it is a good idea to inculcate the habit of saving some money to meet financial emergencies: to build an emergency fund. Financial emergencies could be in the form of a medical crisis or a an accident that you may have when travelling. This fund should be available with you instantly in the form of physical cash, however not highly recommended, or on a checkings account wherefrom it is possible to make quick withdrawals from bank ATMs.

As a rule of thumb it is generally considered prudent to set aside 4-6 months of your monthly salary to be able to pay for any unexpected bills.

In case you do not have any loans and have some money already saved; you could consider investing. The decision to invest depends on the time frame for which you are able to put money aside without needing it and the risk that you are willing to take with money.

Savings are usually used to meet your short term needs. Investments on the other hand, generally entail a longer horizon: from six months up to several years or even onto your retirement (if you wish to invest to for your pension needs).

The goal of investing is to provide returns that are higher than what you can earn on your savings account, and grow your money over a period of time. The amazing aspect of starting early with investing is that you will benefit of the power of compounding

TIPS

• Don’t spend all your money, but make sure you save or invest some for future needs.
• Set aside 3-6 months of your monthly savings to create an emergency fund
• If you have the ability, start investing as early as possible as you will benefit a lot from the power of compounding.