Month: September 2008

The amazing truth of partial Profit booking

Posted on by Jagoinvestor

In this article I’m going to talk about importance of partial profit booking. The scope of this article is only risky investments where we have risk of loss. It’s not related to Debt products where we are sure of returns.

Partial profit booking is relevant if you invest in Shares, mutual funds or derivative products.

truth of partial Profit booking

What is the main goal of investments in Equity?

When we ask this question, most of the people would get it correct, Answer is Capital appreciation or fast growth of money. But most of the investors concentrate so hard on maximizing profits that they underestimate risks and that’s the main reason for most of the losses they make.

The biggest goal while doing Equity investments has to be “Capital Preservation” and only then you must think about any profits. So the main concentration must be on “Capital Preservation”. If you don’t concentrate on capital preservation, it can erode because of continuous losses and then you will have to try for profits just to get back to level you started.

Suppose by taking a lot of risk you can either earn 60% or lose 60%. If you get profits, it’s great. But if you lose 60%, then you will have to earn 150%, just to get back to your starting Capital. Whereas if you take a less risky route where you just earn 10% or 15%, your money will grow slowly and steadily, it will soon increase due to compounding effect.

We are investors, we are not god, we can’t predict markets move accurately. We can only avoid bad moves and take decisions which can help us minimize our risk and losses. We will soon see how Partial booking of profits can is so important while doing investments.

What is partial booking of Profits?

When we invest our money and if we get some profit and then we are not sure what can happen next, we book a part of it to minimize our risk. The main idea here is that if we gain some profits, we should book some part of it to make sure that we already got that profit in hand and not just in mind.

For Example

Ajay invested 1,00,000 in shares, which grew by 20% in 6 months. Now he is not sure what can happen, Markets are uncertain and now there might be 40% profit or 40% loss (just for example). He has 3 options here

1. If he does not book partial profits

His investments grew to 1,20,000 and now he can get profit or loss of 40%. Let us see the range of his return.

In case of 40% profit, he will get 1,20,000 * (1 +.4) = 1,92,000
In case of 40% loss, he will get 1,20,000 * (1 – .4) = 72,000

Total investment: 1,00,000

Returns: In range of -28% to +92%

2. If he books partial profits

Here we assume that he books his 50% profits. His investments grew to 1,20,000 and books profit of 10,000, he get backs 60,000 back and rest 60,000 is still invested. Let us now see the range

In case of 40% profit, he will get 60,000 * (1 +.4) = 96,000
In case of 40% loss, he will get 60,000 * (1 – .4) = 36,000

As he has got back 60,000 back earlier, the actual range will be

If 40% profit: 1,56,000
If 40% loss: 96,000

Total investment: 1,00,000
Returns: -4% to +56%.

So there is choice between -28% to +96% or -4% to 56%. The good idea will always be the second option. Because the second option is more close to giving positive returns. It saves us from risk. It makes sure that even though less, we get positive returns.

To understand more on why avoiding bad decisions is better than making good ones, Click here

Let us see another example :

Just before the NSG waiver meeting, Robert invested 35,000 in options, he was very sure that markets would rise. Just after news came about NSG waiver, markets were suddenly up and He was in 12k profit overnight. This was a positive news for market and he wanted to remain invested.

He was very sure that market would rise further for next few days and his money would grow to 60-70k. People who are familiar to option trading will know that 30k can become 60k or 90k in a single day.

Robert was so confident that he did not book partial profits. Next day there was Lehman Brothers Collapse and it was a great shock to world. From next day stock markets fell and his investments fell by 90% in 2-3 days. His money grew from 35,000 to 47,000 and then fell to 8,000 in 3 days. Now he was in 27,000 loss.

What if he would have booked partial profits?

If he would have booked 50% profits. It means he invested 35k which grew to 47k and he takes out 50% of his investments, He should have taken out 23k and left 24k invested. In that case even if markets feel by 80%, His 24k would become 5k. Remember here, that he has already booked half of his profits and his exposure has reduced by 50%, which will help him in minimizing losses.

Total investments = 35,000
Final value = 23k (booked earlier) + 5k = 28,000

Loss : 7,000

Summary

Markets are uncertain and volatile. If we get profits anytime, make sure that they are partly booked, By doing that, you make sure that you have actually got some profit materialized and reduced your exposure to investments after it has gone up. If your investments start falling again, you will suffer some loss, but that loss can be compensated by the profits you have already booked.

By partially booking profits you reduce your risk for huge losses, at the same time you also cut your chances of making large profits, which is fine. Concentrate on cutting and avoiding losses and risk and not making profits. Profits will automatically come once you know how to manage your risk.

How to hedge your Portfolio using Derivatives

Posted on by Jagoinvestor

When it comes to invest in equities or mutual funds lots of people becomes concern about their investments. This article is surely for you if you invest in Equities (Direct shares or Equity Mutual funds). In this article I’m going to tell you how to hedge your portfolio using Derivatives.

Using derivatives to hedge risk

Risk Management of Portfolio using Derivatives

Many people might have seen their investments go down to anywhere between 20-50%, if they invested in Indian Stock markets around Dec 2007 or Jan 2008, and they might be wondering if it will go more down in value .

Just like we know take life Insurance to cover the risk of Life, Home insurance or car insurance to cover the risk if anything goes wrong, Can we also take Portfolio insurance?

What does insuring the portfolio means?

What does insurance means? It means securing something from some event which can cause loss or damage. We ensure our Lives, our homes, our Car. What happens when nothing happens to our lives, Home or Car.? We pay a small price for it and that is a kind of fees, which we pay for the security.

In the same way, we can also insure our portfolio, we can make sure that our loss is limited, the loss is always limited. If you are one of those who invested in Equity mutual funds or Shares during 2007 or Jan 2008, and you are sitting on a loss of 30-60%, you will understand this very well.

Anyone who invested Rs.1,00,000 in stocks or mutual funds has loss of anything from 30,000 to 60,000 (depending on his investments). Just wonder if they could insure their portfolio and make sure that there loss cannot go beyond a certain limit. That would be wonderful. We are going to discuss this today.

How to insure your portfolio?

There is no specific product or service for this , you have to manage it using Options (Derivative Products). ( Read it in Detail)

I assume that you now understand what are Options and how do they work , what are call and put options and what is expiry date, in case you have not read about it, please read it at above links (try first link to get basic info).

If you have invested in Mutual Funds

Ajay has invested Rs.2,00,000 In Equity mutual funds in Aug 2008, Nifty is around 4,200. He has invested his money for 4 months and would like to withdraw his investments in Jan 2009. He is a smart investor and knows that markets can crash and there is no limit to how much down it can go, so he decides to minimize his risk.

For this he has bought Nifty 4200 PA DEC-2008 trading at 200, for which he spent Rs.10,000 (Rs.200 * 50 lot size).

Now let’s see 3 different cases and what happens to his portfolio

1. Markets boom and goes up to 5,000 : Nifty has gone up by 20%

I am assuming that his investments followed and his Rs.2,00,000 has grown to Rs.2,50,000

Value of his Nifty PUTS : 0

Profit from investments : 50,000
Loss in Puts : 10,000

Total Profit : 50,000 – 10,000 = Rs.40,000

2. Markets Crash by 25% and nifty goes down to 3,100.

His investments follow and now its value is around 1,40,000, but his PUTS will be valued at 1,100 (4200-3100). So its value at the end would be 1,100 * 50 = 55,000.

Loss in investments : 60,000
Profit in PUTS = 45,000 (55,000 – 10,000 investment)

Loss = Rs.15,000

Here you can see that Out of his loss of 60,000, 45,000 is covered from PUTS.

3. Nothing happens and markets are still at 4,200.

His investments will be almost same, and his PUTS will expire with value 0.

Profit from investments : 0
Loss from Options : 10,000

Total loss : Rs.10,000

In all the 3 cases, we should note that in all the cases his Losses are minimized.

Let us also take an example of Shares.

Ajay bought 300 shares of Reliance @2,000 on 1st Jun 2008. He wants to sell these shares around Dec 2008.

He senses that markets are uncertain, so he buys 4 lots of RELIANCE 2,000 PUTS DEC 2008 @100. One lot of Reliance options has 75 shares, that’s the reason he buys 4 lots, so that he has total 300 shares control.

What does it mean? It means that on Dec 2008, he has the right to see 300 shares of reliance @2,000 and for this right he has paid Rs.100 for each share.

The maximum loss for him is now Rs.100 per share.

Let us see the 3 cases.

1. Shares price has gone up to 2,500.

Profit in shares = 500 * 300 = 1,50,000
Loss in Puts = 100 * 300 = 30,000

Total profit : 1,20,000

2. Shares price remain same at 2,000

Profit in shares : 0
Loss in Puts : 100 * 300 = Rs.30,000

Total Loss = 30,000

3. Shares price go down to 1,500

Loss in shares = 500 * 300 = 1,50,000
Profit in Puts = 500 * 300 = 1,50,000 – (30,000 investments)

Total Loss = 30,000

Again, we can see that in any case his loss is capped by 30,000 (5% of his investments of 6,00,000)

So options can be used to hedge or security. Watch this Youtube video to understand.

Summary

So the main idea of options is to use them to minimize the losses. If there is loss in investments, the puts will end up in profit and we will have very less loss or maybe we can get some profits only. The same way, if people do short selling they can use calls to minimize their losses.

So if you have invested in Shares or mutual funds and want to minimize your losses, use options or Futures as Hedging tools.

What are Gold Mutual Funds

Posted on by Jagoinvestor

Gold Funds

In India Gold investment is considered as the traditional and most safe toll for investment. In this article I’ m going to tell you what are the alternatives to invest in GOLD other than physical Gold and GOLD ETF?

gold etf

What are Gold Mutual Funds?

Gold Funds are mutual funds which invests in stocks of companies engaged in gold mining & production. They do not buy gold directly but invests in stocks of companies engaged in gold mining and production world over.

When gold prices rise, the profitability of gold companies tends to increase more than proportionately, thereby providing long-term capital appreciation as stocks of gold companies have the potential to outperform gold prices by a significant margin over the long run.

Even though these are Gold funds, they can invest some part in Platinum and Silver.

According to the website, DSPML World Gold Fund has invested over 80 per cent in gold followed by platinum (9 per cent) and silver (5.10 per cent).

As per the December 2007 portfolio, Australia based Newcrest Mining is the top holding of the fund accounting for 8.4 per cent of the fund’s assets, followed by Barrick Gold (7.50 per cent), Kinross Gold (5.50 per cent) and Lihir Gold (5.20 per cent).

Why to invest in These Gold Funds?

Investors can benefit from the global demand for gold by investing in the precious metal and in companies involved in its production. In times when Equity markets are uncertain , Gold can be a good hedge. After Equity markets crash of Jan 2008, Gold Mutual funds were the best performers in any Mutual Funds category.

Also, this fund has an edge over GOLD ETF’s (What are GOLD ETF’s) as the portfolio of gold equities is actively managed as against the passive management in Gold ETFs.

Click here to know the returns of gold investment in past few years.

Taxation and Returns

From the taxation point of view, These fund will not enjoy the tax benefits that equity funds are eligible for. Long term gains would be taxable at 10% and short term gains would be taxable as per slab rates applicable to the investor.

Most of the Gold mining companies will be outside India and hence these funds would eventually be invested in dollar denominated assets, any currency fluctuation would directly affect your rupee return.

For example – the US dollar has depreciated by over 8% in the last 3-4 months against the rupee. Such appreciation of the rupee directly eats into a dollar return and investors should be aware of the currency risk that they undertake when they invest in this fund.

What are Gold Funds Available (In India)

– DSPML World Gold Fund
– AIG World Gold Fund

Read Why to invest in GOLD and What is the Best way
Read How to Calculate your Life Insurance ?
Also read Creating Wealth for retirement

I would be happy to read your valued comments. Thanks ………

How to calculate Insurance Requirement

Posted on by Jagoinvestor

There are lot of assumptions related to buying life insurance in India, because of underestimating the future non-life threats like job loss, accidents and also the life threats which will have a bad impact on your families future requirements in case of your untimely demise.

Today i will discuss about the calculation of insurance Amount one needs to protect his family even though he will not be there for them.

Life insurance

How much should be the Insurance cover?

You will hear that it must be 6-7 times of Gross yearly income which is good enough estimate. but it does not consider other things like Debts or living style. It may be true for you but not for other. Some people may have simple lifestyle, whereas some other can have expensive lifestyle. So lets answer this question in another way.

This is pretty easy to answer, The life Insurance amount much be enough to –

  • Pay off all the debts
  • Should be able to provide monthly income which is good enough to cover family expenses
  • Any emergency or unplanned needs for future.

How to calculate the Sum Assured?

While deciding the  total sum assured, you need to consider all the factors that may affect to the financial life of your beneficiary when you will not be around. You should understand the expected cost of living for your family in your absence.

Some of the basic aspects that you should take into consideration in order to calculate the total sum assured are listed below:

  1. Calculate the total one time expenses which can be paid in lump sum also, like, Loan, credit card bills etc.
  2. Make a addition of all the assets like mutual funds, stocks, FD/RD, property etc. (Exclude those assets which your family is not willing to redeem or offset with the lump sum amount of liabilities)
  3. Deduct the liabilities from the assets ( or assets from liabilities in case liabilities are higher)
  4. Calculate the annual expenses of your family
  5. Decide the number of years for which you want to provide insurance cover
  6. Consider this amount for as a sum assured for your life insurance cover.

Let’s take an example.

Example :

Ajay is 30 yrs old and earns 40,000 per/month. He is married and has 2 kids. There monthly expenditure is 20,000 per month.

  • His debts and future expenses.(total : 47 lacs)
  • Home loan of 24 lacs (remaining)
  • Car loan of 3 lacs.
  • His children studies expenses. (20 lacs , in future)

His investments are (total 8 Lacs)

  • 5,00,000 in Fixed Deposits
  • 3,00,000 in Mutual funds

He has 47,00,000 worth of Debts and expenses in future and monthly expenses of 20,000 , considering inflation @5% , which will also increase every year. His Insurance money should be able to pay for both of these.

We have to answer that how much money will provide 20,000/month (post-tax) or 2,40,000/year.

Considering 15-20% tax, the family should get 3,00,000, so that after paying tax they are able to get 2,40,000 per year. So how much money will give them 3,00,000 per year.

Fixed Deposits rates are around 9-9.5% per year. Which means 3,00,000 X 100 / 9.5 = 32,00,000 (approx).

So if they have this much amount in Bank which pays interest of 9.5% yearly, they will receive around 3,00,000 per year as interest and after paying taxes, they will be left with 2,40,000, which can meet there monthly expenses.

Also the insurance amount should have 47 lacs extra, which will be used to pay there debt and future expenses.

So total = 32,00,000 + 47,00,000 = 77,00,000

As he has 8,00,000 worth of investments also, His Insurance needs comes down to 77,00,000 – 8,00,000 = 69,00,000 (let’s make it 70,00,000)

This is the minimum amount for the insurance needs.

It should also be considered that the expenses will rise and some emergency may also happen. So insurance can be increased by 10-15%. But for the moment we will not do it. Its in fact not necessary in this case because the money for future expenses can be invested and which will grow .

Tracing Back

So we arrive at the figure of 70,00,000 . Now lets go back again and see that in case there is sudden death of the family head (earning member), how this money helps the Family..

They receive 70,00,000, Out of which they pay 24,00,000 of home loan

Money left = 70,00,000 – 24,00,000 = 46,00,000

They put 32,00,000 in bank or Monthly income plans, which will provide them with monthly income of 20,000 per month (post-tax).

Money left = 46,00,000 – 32,00,000 = 14,00,000

Now this 14,00,000 can be invested in Debt or Mutual funds which will grow to become at least 20,00,000 in some years (considering its needs after 10 yrs at least.

At the end of 10 yrs, when family needs this 20 lacs for there children education, they can use it. And for any emergency needs they have another 8,00,000 in investments.

So in general All the requirements of Family is taken care of. If insurance amount is less than 70,00,000 they will have to compromise at one place or the other.

Why it is necessary to have as life insurance cover?

Life insurance is an important instrument to make your dependents life secure, in case of your untimely demise.

Life insurance requirements

Though there is nothing great in that, but most of the people miss on this part and according to studies, more than 80% of people in India are under insured, which means the amount there nominees will get will not be able to cover them against the financial crisis.

In case you have not read my previous articles on Life insurance, please read them

How much will the Life Insurance cost him per year?

As I write this Article, I can see on https://www.click2insure.in/ that for a 30 yrs old non smoking male for 25 yrs of cover, the minimum premium per year for 70,00,000 Term Insurance is Rs.21,000 per year (taxes extra).

The premium is just 4.4% of this yearly income. Just imagine how cheap term insurance for total peace of mind for rest of the life.

So whats the final formula?

Insurance cover = A + B + C – D

Where,

A is Money which can give you monthly income = Monthly expenses * 12 * 100/(interest rate which bank gives in a year , example 9.5%)

B = Future Debts or Expenses.

C = Some money for contingency or emergency.

D = Your investments or Assets (excluding HOME)

If you are under insured, please take extra life insurance and cover your family. You can also buy insurance under MWP act.

Please read my earlier articles on Term Insurance to understand more.

I would be happy to read your comments.

Some of the best investment products I know about

Posted on by Jagoinvestor

When it comes to investment, everyone is conscious and curios to know about the best investment products. In this article I’m going to tell you about few of such products that I know and I thing they will be helpful for you.

Best investment products

1. Term Insurance

Term plan is an affordable insurance which provides a full protection cover for your family at a very low premium cost. One of the best products in Term insurance markets I know is SBI life Insurance Shield Plan.

Before taking any Insurance into consideration, we should give importance to

  1. Premium amount you pay : Premiums are among the cheapest in market
  2. Claim settlement Rate : Next only to LIC

There Shield plan is designed very nicely, have a look at it and you will love it.

2. UTI Gold ETF’s

It is simply an investment in gold which tracks it’s price on day to day basis. It has its own expense ratio which is very high is compared with US market, but it is the price that we pay to invest in gold electronically. You should have a demat account to invest in Gold ETF’s and you can trade these ETF’s through stock market.

If you want to invest in GOLD, try this ETF, search GOLDSHARE or UTGOLD (if you are on ICICIDIRECT).

3. Mutual Funds

Mutual funds are categorized on the basis of its objectives, style and strategy. Investing in Mutual Funds only is not enough to get good returns. You should know about the types of mutual funds and then invest in different funds by deciding your goal.

See here some of the good options of mutual funds to invest in :

ELSS

  • SBI magnum tax shield
  • Principal Tax saving

Equity Diversified Mutual Funds

  • DSPML Equity
  • HDFC top 200
  • Magnum Contra

Balanced Funds

  • HDFC Prudence
  • DSP Balanced
  • UTI Mahila Unit Scheme

Debt or Liquid Funds

  • Kotak Flexi
  • Birla Sun Life Income

(see details of these mutual funds at https://www.valueresearchonline.com/)

3 most Important formula’s you should know – Compound interest, CAGR and Annuity calculator with example

Posted on by Jagoinvestor

1. Compound Interest

This formula is often used to calculate the returns some investment has given. The main concept in compound interest is that interest gets accumulated with the total principal amount and that interest again earns interest over the years. Which makes it very powerful.

Compound Interest, CAGR and Annuity - Important formula's

Formula : A = P * (1+r/t)^(nt)

Where,

P = principal amount (initial investment)
r = annual interest rate (as a decimal)
n = number of times the interest is compounded per year
t = number of years
A = amount after time t

Example 1 :

Investment = Rs.10,000
return = 9%
investment period = 8 years

Total amount = 10000(1+.09)^8 = 19925.63

Example 2 :

Sensex returned 17.3% return over 29 years since its inception in 1979. What would be worth of Rs 10,000 invested that time.

A = 10,000 * (1+.173)^29 = 1022450.64 (10 lacs)

You can see that a small amount has actually grown to 100 times.

Compound interest Calculator :

https://math.about.com/library/blcompoundinterest.htm

2. CAGR

This tool is very important because it helps in comparing two differnt returns from two investments, you can calculate how much an investment has returned per year on compounded basis, Its just the opposite of Compound interest

Formula : CAGR = (A/P)1/n – 1

where:

A = Final amount
P = amount invested
n = Number of years

CAGR can be a great tool to compare two different investments and there returns.

Example :

A. 10,000 invested in a XYZ mutual fund for 2 yrs became 20,000
B. 50,000 invested in GOLD for 7 years became 4,00,000

Which investment has given more returns?

Here the main doubt is that how to calculate which one is better .. the amount, tenure is different. So in this case we calculate and see CAGR, one with more CAGR will be good.

A) CAGR = 41.42 %
B) CAGR = 34.59 %

So, investment in A is better than B. Which is –

CAGR calculator :

https://www.moneychimp.com/calculator/discount_rate_calculator.htm

3. Annuity

This formula is very very important one, in our daily life we come across many situation where we do a fixed payment at the fixed interval, and we want to calculate the returns, but we don’t know how to do it .. Example can be

  1. Monthly payments in Mutual funds through SIP
  2. Yearly payment in a PPF.

Or any investment at a fixed inteval over some years. In that case we calculate the Final value using formula called Annuity.

Formula : A = P * [{(1+i)^n – 1 }/i] * (1+i) (if payment are being made at the start)
(it will be P * [{(1+i)^n – 1 }/i] if payments are made at the end of the year)

Where :

A = final amount
P = installment each time
n = total number of installments
i = interest rate for that tenure (example if yearly return is 24%, but payments are made monthly then i = 24/12 = 2%)

Example 1 :

Robert invests 10,000 each month in a mutual fund for 10 years and the annual return was 18%, what will be his final corpus?

Here as payments are monthly, total payment will be 10 * 12 = 120

so n = 120 and i = 1.5 % (18/12)

A = 10,000 * [{(1+ .015)^120 – 1}/.015 ] * (1+ .015) => 40,39.241 (40 lacs)

Example 2 :

Vikas is planning his retirement, and planning to invest 5,000 per month in a Mutual fund for 20 yrs where he expects a return of 15%, then take out all the amount after 20 yrs and then put it in a FD for 15 yrs which gives him 9.5% return.

Here, we there are two parts

A. He makes monthly payment for 20 yrs (here we have to apply annuity)
B. then he takes the money out after 20 yrs and then put it in FD for 15 yrs (as this is one time payment, here we will apply compound interest)

A ) n = 240 and i = 1.25% (as the payment are monthly)

His money after 20 years = [5,000 * (1 + .0125)^240 – 1) / .0125] * ( 1.0125) = 75,80,000 (75 lacs)

Now he invests this money into a FD for 15 yrs at 9.5%.

B) Final amount = 75,80,000 * (1.095)^15 = 2,95,00,000 (2.95 crores OR 29.5 millions)

So his final corpus will be 2.95 crores.