Post on 10-Jan-2016
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Basics of Investment
2005
Brunei Investment Agency
Contents
When to Invest
Establishing Personal Investment Policy
Return and Risks
Horizon and Liquidity
Example - Policy
Summary
Appendix
Setting up Priorities
1. Savings for Emergencies
2. Insurance Cover (accidents, medical, life)
3. Investment
Traditional Investment
Cash– Liquid Assets, pay interest– Eg. Short term deposits, Treasury Bills
Bonds– Fixed Income Instrument, pay coupons (or
interest)– Eg. Government Bonds, Corporate Bonds
Stocks– Shares in companies, pay dividends– Eg. Microsoft shares , IBB shares
Cashflow Cycle
Raise finance through loans, issue bonds or shares
Pay off loans and interest, redeem bonds and payoff coupons, and distribute profit
through dividends
Balancing the Proportions
• How to balance the weights of each assets?
Cash
Bonds
Equity
10% ??
45% ??
45% ?
Which Ones to Buy ?
Stocks have generally outperformed at some point or another, hence have received quite a lot of attention.
Microsoft Shares? Tech Stocks? Value Shares? Biotech? Growth Stories?
Long term bonds? Munis? Asset Backed?
Lots of Questions – Need Lots of Answers?
Answer :
Depends on your
Goals
Age
Asset Size and
Risk Tolerance ….
Contents
When to Invest
Establishing Personal Investment
Policy
Return and Risks
Horizon and Liquidity
Example - Policy
Summary
Appendix
Setting up Investment Policy
1. Return Objective (Goals)
2. Risk Tolerance
Subject to ;
a. Time Horizonb. Liquidity Requirementc. Laws & Regulationsd. Taxes where applicablee. Unique Needs
1. Return Objective (Goals)
Finding the right Return Objective
– Eg. To double your money in 10 years.
– Steady return over long periods of time
– To get $1,000,000 in 30 years
– To get $100,000 in 6 years
– etc
Data From 1926-2001 (US)
Asset TypeAverage Return per
year
Large (Blue Chip) Stocks 10.7%
Small Stocks 12.5%
Long Term Corporate Bonds 5.8%
Long Term Government Bonds 5.3%
US Treasury Bills (Cash) 3.8%
Return in US Stock Market
Eg. US Stock market investment of US$100 in Dec 1981S&P 500
1981 $100.00
1982 $114.76
1983 $134.58
1984 $136.47
1985 $172.40
1986 $197.61
1987 $201.62
1988 $226.62
1989 $288.37
1990 $269.46
1991 $340.34
1992 $355.54
1993 $380.62
1994 $374.76
1995 $502.59
1996 $604.44
1997 $791.86
1998 $1,003.04
1999 $1,198.90
2000 $1,077.34
2001 $936.83
2002 $717.93
2003 $907.32
2004 $988.92
Investment in US Stock Market
US$100 Investment in December 1981 turned to a handsome US$988 in December 2004
0
200
400
600
800
1,000
1,200
1,400
S&P Monthly Returns
Monthly Returns of US Stocks have been Volatile
-25%
-20%
-15%
-10%
-5%
0%
5%
10%
15%
• Source : Stocks, Bonds, Bills and Inflation 2002 Yearbook
Volatilities of Stock Market
100
200
300
400
500
600
700
Volatilities of Traditional Assets
100
200
300
400
500
600
700Equity
Bond
Cash
Volatilities of Bond Market
100
200
300
400
500
600
700
Setting up Investment Policy
1. Return Objective (Goals)
2. Risk Tolerance
Subject to ;
a. Time Horizonb. Liquidity Requirementc. Laws & Regulationsd. Taxes where applicablee. Unique Needs
2. Risk Tolerance
• Setting Return Objectives needs Risk Parameters
– No pain No gain : No risk No Return
• What Risk to assume??
Investing in Shares of Companies
Risks in Investing in Shares of Companies– Specific Risk (companies can be unprofitable and at worst
can go bankrupt)– Sector Risk (share price can also fall along with other
companies within the same sector)– Market Risk (share price of a company can also fall with the
rest of the stocks in the same market)
These risks need return compensation. Sometimes you are well compensated, other times you are not.
Solution : DIVERSIFY, across many stocks, many sectors, many markets.
Simpler solution : BUYING INDEX FUND
Return and Risk
Historical return of various asset classes against the risk (annualized)
Sources : Various
0%
5%
10%
0% 5% 10% 15% 20% 25% Risk
Return
US Bonds
US Equity
Diversification : Combining Assets
Benefits of Correlation between asset classes
Stocks and Bonds rises and falls at different times
Setting up Investment Policy
1. Return Objective (Goals)
2. Risk Tolerance
Subject to ;
a. Time Horizonb. Liquidity Requirementc. Laws & Regulationsd. Taxes where applicablee. Unique Needs
a. Time Horizon
• Risk and Return objective usually have different parameters depending upon time horizon of the investment
• Age plays an important role for individuals.
• Example Return Objective of Setting a Retirement plan (at the age of 55)
– A person who is 25 for instance, will have a different set of risk tolerance compared to another who is already 48 years old.
Phases of Life
Setting up Investment Policy
1. Return Objective (Goals)
2. Risk Tolerance
Subject to ;
a. Time Horizonb. Liquidity Requirementc. Laws & Regulationsd. Taxes where applicablee. Unique Needs
b. Liquidity Requirement
• Again, Risk and Return objective usually have different parameters depending upon Liquidity Requirement from the investment fund
– Example, the need of a regular income as opposed to one lump sum payment
– or the need of a big payment (example a new house) at age of 40. This liquidity requirement has to be incorporated when we set up the portfolio
Setting up Investment Policy
1. Return Objective (Goals)
2. Risk Tolerance
Subject to ;
a. Time Horizonb. Liquidity Requirementc. Laws & Regulationsd. Taxes where applicablee. Unique Needs
Other Considerations
• More Diversification– Alternative Asset Classes
• Other Risks– Currency, Country, Counterparties etc
• Regular Investments versus Lump Sum Investment
More Diversification
Spreading your risk by investing in a variety of assets to protect
your overall investment without sacrificing too much of expected return.
Need to find the optimal diversification mix from a variety of instruments available subject to again your age, asset size, tolerance for risk and investment goals.
Various Asset Classes and the Risk Profile
Contents
When to Invest
Establishing Personal Investment Policy
Return and Risks
Horizon and Liquidity
Example – Mr Ash Burn
Summary
Appendix
Investment Policy Example : Mr Ash Burn
1. Return Objective (Goals) :
Wishes to have monthly income of US$5,000 at the age of 56 - for 24 yearsWishes to travel a lot when retired, US$ requirement not a priority
2. Risk Tolerance
Medium to High Risk (Age is 24 earning US$2,000/mth 5% increment/year)Don’t really mind currency risk – Wish to have multi currency exposure
Subject to ;
a. Time Horizon - 31 years to go before 1st Payment
b. Liquidity Requirement - No real need of liquidity from this
investment fund
c. Laws & Regulations - US law & regulation applies
d. Taxes where applicable - No tax concessions
Investment Strategy Example : Mr Ash Burn
Based on the policy set in the previous slide, example recommendation for Mr Ash Burn is as follows;
AllocationExpected Return
Volatility
US Equity Index 20% 9.2% 21.7%
Developed Market Equity Indices (non-US)
30% 6.3% 18.9%
Emerging Market Equity Index Fund 20% 11.1% 27.9%
Private Equity Fund 15% 19.0% 20.0%
Long term Fixed Income Funds 15% 1.2% 6.5%
Total 100% 9.0% 15.0%
Investment Requirement
Given 9% Annual Return Expectation, Mr Ash Burn will need to come up with either
– a lump sum investment amount of US$ 40,753,
or
– an annual investment of US$ 3,615 ($301/mth)
20%
30%
20%
15%
15%
US Equity Index
Developed Market Equity Indices (non-US)
Emerging Market Equity Index Fund
Private Equity Fund
Long term Fixed Income Funds
Investment Requirement
• If Return Expectation is more moderate 6.5%, need;
– a lump sum investment amount of US$ 103,896,
or
– an annual investment of US$ 7,390 ($616/mth),
Or an even better (less painful alternative)
• $4,885/year (but increasing this payment by 5% per year),
hence monthly installment will be $407 on the 1st year, $427 in
the 2nd year, and so on and so forth. At 52 for instance, he will
be paying $956/mth.
Perhaps this will be an easier option as he is assumed to earn
more as he grows older
Policy Review – Mr Ash Burn
1 year later, the investment policy is reviewed
Return expectation may change, or his risk appetite may change, or he suddenly decides he wants to incorporate a mansion when he is 60 and is willing to receive less monthly annuities
All of which will require a different investment strategy and hence different monthly installments
Contents
When to Invest
Establishing Personal Investment Policy
Return and Risks
Horizon and Liquidity
Example - Policy
Summary – 4 Key Points
Appendix
4 Key Points
1. Set up Investment Policy - Return & Risk goes hand in hand
Avoid “get-rich-quick-and-no-risk” schemes
2. Regular Review of Investment Policy At least once a year Adjust Risk Lower Towards Maturity
3. Regular Investments Avoid the need to time market Entry points are averaged over the long run Painful lump sum investment can be avoided
4. Diversified Portfolio Fund Type Investments generally simpler Avoid the pain of being hit by specific risks
Appendix
Some useful sites on Index Funds, ETFs and financial glossary
• www.fool.com
• www.investorguide.com
• www.bloomberg.com
• www.investorwords.com