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Active Vs Passive Investing

Active Vs Passive Investing In last few articles, we have covered topics ranging from the need for investing, diversification to importance of asset allocation. In this article, we look at two different styles of investing. Investing is the process of putting aside money in a chosen asset class today, in order to get ‘more’ money in future.Even though the goal of every investing exercise is similar, i.e. to achieve higher returns, the process/style of achieving it can be different. There are two important styles of investing: 1)Active Investing 2)Passive Investing Lets discuss these two styles in detail. Active Investing The whole purpose of active investing is to try and outperform the broader markets.To illustrate, you pick stocks on your own, you are investing actively. Since the idea of investing on your own is to get higher returns than broader markets, you would try to generate returns that are able to beat the returns given by broader market indicators like Sensex, Nifty 50, etc. It requires one to analyse companies, buy and sell shares,...

Understanding the relationship of Risk & Return

Understanding the relationship of Risk & Return “Stocks are risky. Bank deposits are safe. Don’t buy stocks! Keep your money safe.” Haven’t you heard such statements before? We are sure you have. But before you decide to accept these statements on their face value, we suggest you understand the real relationship between risk and returns. To start with have a look at the average historical returns given by these 2 assets, i.e. stocks and bank deposits: One glance at the table above and it becomes clear – which is the better asset to invest in,given the historical average returns. Another thing to note here is that returns given by bank deposits will be further reduced when we consider taxes.This makes stocks all the more better option for long-term investing. But unfortunately, stocks don’t go up in straight lines. Stocks are volatile and can move up or down sharply. This is unlike bank deposits, which are almost guaranteed to give fixed returns promised at the time of booking the deposits. But before you draw a negative conclusion...

Importance of Choosing Asset Classes to invest in – Asset Allocation

Importance of Choosing Asset Classes to invest in – Asset Allocation Stocks, bonds, real estate, gold and cash – there are the many asset classes that fight for a place in investors’ portfolio. Within this categorization of physical and financial assets, there are few major types of assets: But with so many available options, how should an investor decide which ones to choose and which ones to ignore? Or what percentage of the total portfolio should be parked in each of these assets? For an investor, this is one of the most important money-related decisions, which he/she needs to take. And this is what is popularly referred to as deciding the asset allocation. Having the right asset allocation helps earn better risk-adjusted returns at the overall portfolio level and also, reduce the overall risk and volatility. So what exactly is asset allocation? Asset allocation is the process of allocating your money into various asset classes. The primary goal is to have a well balanced portfolio, where fall in value of one asset is adequately compensated for by rise in another....

Introduction to various Asset Classes

Introduction to various Asset Classes An asset can either be physical (can be touched and used like gold, real estate), or it can be financial (can be bought in form of contractual certificates like stocks, deposits, bonds etc.)Within this categorization of physical and financial assets, there are few major types of assets: Stocks: Stocks are representative of part-ownership in the company whose stock is being bought. Out of the profit that the company makes, a part is paid out to shareholders (stock owner) as dividends. Rest of the money is invested back in the business. In general, company’s growth potential decides how the markets value the stock. So if the markets think that company will do well in future, its share prices might go up. So in addition to dividends, shareholders also earn money by means of capital appreciation when they sell shares held by them at higher prices. Unfortunately, stock prices don’t always move up in straight line, i.e. returns are not guaranteed. But on an average, stocks are known to provide the...

Time Value of Money

Time Value of Money Can you buy the same amount (value) of things for Rs 1000, that you were able to buy 5 years back?The answer is surely going to be a big ‘No’. After all, prices of almost everything are rising every year. This is what is generally referred to as the effect of inflation. On a similar note, a Rupee today is worth more than a rupee in future. Isn’t it? On a similar note, a Rupee today is worth more than a rupee in future. Isn’t it? It is because you can take a rupee today and earn interest/dividends/etc. on it. So it takes more than a rupee in the future, to equal a rupee today. This is what is broadly, the concept of time value of money. The money available today is worth more than the same amount in future, due to its potential earning capacity. Now within this idea of Time Value of Money, there are 2 important terms that everyone must be familiar with: Present Value (PV)...

Power of Compounding

Power of Compounding Compounding – Unfortunately, this is one concept which most people would have studied in school days, but no longer seem to remember. Caution: If you don’t understand this concept now, you can loose a lot of money in future. As a reminder, compounding refers to the re-investment of income at the same rate of return to constantly grow the principal amount, year after year. Suppose you put Rs 1,00,000 in a bank fixed deposit giving 8% annual returns (lets ignore taxes for simplicity). Now after a year, your principal of Rs 1,00,000 would have earned Rs 8000 in interest. If you reinvest that interest(Rs 8000) along with the original Rs 1,00,000, what will happen in next year? You will get another Rs 8000 from your original Rs 1,00,000 investment, plus Rs 640 from the reinvested Rs 8000. If you reinvest all your returns, the total value of your original Rs 1,00,000 investment after 5 years would be as follows: At end of Year 1: Rs 1,00,000 earns 8% =...