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Thursday, February 11, 2016

Know Your Risk Tolerance Before Investing in Equities

Dear Reader,

Stock prices were on rise till March last year and we have seen significant increase in retail investors participation compared to previous years. As many new investors get into stock market during such times, its always important for an individual investor to understand what is his/her investment profile and risk tolerance.

Since beginning of this year, with lot of pessimism building around equity market globally, we have seen a severe correction in Indian equities with major indices - Sensex and Nifty falling by more than 22% from all times high made in March last year. If we look into broader markets, stock prices of many mid and small cap companies have seen a steep fall in the range of 30% to 50% or even more since beginning of this year. In such situation every investor looking to create wealth is confused whether to exit, hold or enter the stocks and at what levels to enter or exit.

Being an equity investor, its important to understand what exactly has caused recent fall in Indian equity market. Below are the major factors which hurt the sentiments of equity market in recent times.

i) Continuous Selling by FIIs - Since beginning of the year, foreign investors have sold shares to the tune of Rs. 17,000 crore. With continuous redemption pressure from sovereign wealth funds of the middle east, China woes in terms of sustaining growth, dampening global sentiments led to sell off in emerging markets. Investors who were sitting with hefty profits and invested in Indian stocks during last 18 months also started selling to book profits against falling rupee. Moreover, signs of recovery in the US economy has also resulted in funds travelling from Asian markets back to the US markets.

ii) Slowdown in China Economy - China, world's one of the fastest growing and 2nd biggest economy has shown signs of slowdown. There was a panic because of China's continuous poor manufacturing growth. Moreover, fall in crude prices due to oversupply of oil, fall in base metals prices due to sluggish demand not only hurting China but all the stock markets of the world resulting in major sell-off in markets in US, Europe and Asia.

iii) Weak Corporate Earnings - For any stock market to deliver good returns, it is very important for the earnings of the companies to match its valuations. But in last 18 months, the valuations of India Inc has sky rocketed but the earnings were not seen at par. This was the major concern of the investors and thus we have seen profit-booking in last year and now facing the heat due to redemption pressure in emerging markets from the global funds.

iv) Delay in Reforms took off the Premium - There was lot of expectation from Modi led NDA government with major announcement made to bring reforms by passing two major reform bills - the goods and service tax (GST) and the Land Acquisition Bill. Given the build-up of political opposition to his government, there was more than a fair chance that two major reform bills will not get passed which further impacted Investors sentiments in terms of future growth outlook of Indian economy, this took off the premium valuations which India had last year compared to other emerging markets.  

v) Cognizant forecast slowest Revenue Growth in 14 Years - IT services provider Cognizant forecast its slowest quarterly revenue growth in 14 years, adding to mounting worries about clients keeping a tight lid on technology spending. Cognizant, whose rivals include Indian IT services firms such as TCS and Infosys recently took a beating due to fear of overall slowdown expected in the IT sector. 

vi) Surge in Bad Loans of PSU Banks - A significant surge in bad loans and provisions hurt PSU Bank stocks. Its important to mention here that the Reserve Bank of India recently directed banks to reclassify loans and set aside more money against stressed assets. The central bank has set banks a deadline of March 2017 by which time it expects banks to recognize stressed assets and make adequate provisions to cover them.

vii) Weakness in Indian Currency - Indian currency is trading in the range of 66-68 against the US Dollar amid month-end demand for the US currency from importers and banks. There were cues from the US Fed that the recovery in US economy and the Dow Jones will be on an upward trajectory very soon. This caused a major concern with investors and spooked the Dollar to INR ratio. Hence the falling rupee acted as fuel in hurting market sentiments.

So comes the final question, where is the bottom?

If Sensex hits 22,000, in that case its price to earnings (P/E) multiple will be similar to what it was during the time of Lehman crisis in 2008. That was a stressed situation with lot of fear among global as well as domestic investors like today, The average six-month P/E on a one-year forward basis for the Sensex was 14 times after the Lehman crisis and if we keep the same earnings multiple on FY17 earnings estimates, it gives a target of 22,000 on the Sensex which means correction of another 4-5% from current levels. But we do not want to set any target here, it is just an estimate, Sensex may bottom out around 22,000 levels or it may go down to 21,000 i.e. 30% correction from all time highs made in March 2015 or it may rebound from current level of 23,000.

With every fall, Indian equities valuations are getting attractive day by day. Moreover, once the markets bottom out and form a base, we can see renewed buying interest from global investors. Moreover, upcoming budget can boost the sentiments of investors, hence its time to start accumulating good quality stocks which are now becoming available at discounted price.

We always suggest our members not to time the market and follow a disciplinary approach while investing in equities with medium to long term perspective. Its important to know, whether you would be able to hold on your positions in case stock market tanks?

Historical data indicates that most of the new investors get fascinated towards stock market to make quick bucks and finally end up loosing their capital as they cant hold on their stocks in case market corrects and sell out their stocks in a panic. Stock market is not a money making machine, you need not to be greedy on rising market or fearful when stock market falls, simply buy right and sit tight having sufficient patience with you to see your investment growing over a period of time.

We strongly recommend our members (who are new to stock market) to kindly go through our Asset Allocation Questionnaire to understand your investment profile and risk tolerance.

By answering 15 questions about your risk preferences, you can find out your investment profile and risk tolerance. This score will determine the asset allocation that best suits your risk preferences, you can use our simple excel workbook - Saral Gyan Asset Allocation Questionnaire which suggests the optimum split between cash, bonds and stocks.

The questions are simple to answer, with options provided to select answers using drop-down list, check boxes and radio buttons. They are designed to determine your tolerance to investment volatility, the size of your existing financial cushion, your time horizon, and what you want your investment to achieve.

Saral Gyan Investment Risk Profile & Asset Allocation workbook - Download

The questions asked in the excel workbook includes:

1.What is your total annual income before tax (including investment dividends but not including employment bonuses)?
2.How many sources of income do you have?
3.What is the value of your liquid (or investable assets)? This includes cash plus any easily sold investments like Gold, Bonds and Stocks.
4.What yearly income do you want from this investment portfolio?
5.How long do you intend to hold this investment portfolio?
6.What would you do if your investment portfolio fell in value by one-fifth (20%) over the course of 12 months?
7.What characteristics would you prefer your investments to have?
8.Do you prefer investments which have low volatility and low return, or investments which have high volatility and high returns?
9.What do you want this investment portfolio to do? Preserve capital, generate income, generate income with some capital appreciation etc.
10.What volatility (or risk) are you prepared to tolerate?
11.In the next five years, what percentage (if any) of the portfolio do you plant to sell to realize cash?
12.What kind of investments do you currently own, or would prefer to own? Domestic, international, aggressive, fixed income etc.
13.Assuming a time horizon of ten years, what annual return do you want?
14.Who do you normally get investment advice from?
15.How would you rate your current skill in managing investments?

Your answer to each question is rated with a score. The total score is used to suggest an asset allocation that is appropriate to your risk preferences; the workbook suggests a split between:

■ Cash
■ Bonds (high-yield, long-term, intermediate and international)
■ Stocks (large cap, mid cap, small cap and micro cap stocks)

You can also find out what kind of investor you’re considered; an income investor, a long term investor, an aggressive, moderate or conservative investor. Really helpful, do it yourself. Click here to Download our Investment profile and Asset Allocation workbook.

IMP Note: As our excel workbook is macro enabled file, do enable the macro's while using the file. If you do not understand macro's, do not worry. once you open the file, excel automatically ask you whether you want to enable or disable macro's, simply click on enable and proceed.

If you have patience and want to add extra power in your portfolio, start investing some portion of your savings in fundamentally strong small and mid cap companies - Hidden Gems & Value Picks.   

Time has shown that smart investors have made their fortune by investing in equities in long term. None other asset class can match giving you such extra ordinary returns. Yes, its important for you to invest in right set of companies at right price with medium to long term perspective. If you think to invest in stocks for period of 3 months or 6 months, we suggest you to stay out of stock market because you are not investing, you are betting on volatility of stock market which could be risky. 

Subscribe to Hidden Gems & Value Picks and start investing systematically. Avail attractive discounts by subscribing to our combo packsclick here for details. 

Do contact us in case of any queries, we will be delighted to assist you.  

Wish you happy & safe investing!

Team - Saral Gyan.