investment enviornment

8/13/2019 Investment Enviornment

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INVESTMENT ENVIRONMENT

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INTRODUCTION OF INVESTMENT ENVIRONMENT

To study the investment environment would be of importanceto the investor, as it would also encompass the demand supply matchand mismatch.

Let us visualize the world and its economy. There are many countries withtheir many economies in this environment. We see the interaction betweencountries at different stages in their development. We see the many markets

to enable this interaction between the various countries. Each of thesemarkets has its regulator, the trading platform and its system, its agents (or

brokers), and the participants. Here it is a question of demand and supply ofvarious commodities, products & services and trading instruments. And theanalysis would encompass the demand-supply match/mismatch.

In this global environment, we have India with its economy and its ownmany markets.

Among these markets we have the securities market, with its regulator(SEBI), the trading platform and its systems (stock exchanges), its agents(brokers) and its many participants (including corporate, financialinstitutions both domestic and foreign, mutual funds, insurance companies,

banks and individual investors). Here again it is a question of demand andsupply of various commodities, products & services and tradinginstruments. And the analysis would encompass the demand-supply matchand mismatch.

It would be advisable to note at this stage, that due to the liberalization process undertaken by India over the last 18 years, we are today in anenvironment where events that take place in other parts of the world have adirect or indirect effect on our economy. This would further effect thespecific market and finally would have an effect on the equity market.


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Let us visualize a scenario of an industrial slowdown in the U.S. Amongstother things, this would have a direct bearing (i.e. a reduction) on thedemand of steel. To protect its own domestic steel industry, the U.S.government would temporarily introduce trade barriers on steel imports.This in turn would cause a reduced export of steel from India to the U.S.,causing a temporary over supply of steel in the domestic market. The steelmanufacturers would have to tackle the higher levels of inventory and itsassociated costs. In the domestic steel market, even if the demand wereconstant, the excess supply would cause a reduction in the price realization

per marketable ton of steel. This in turn would directly effect the incomesand profit margins of the steel manufacturers. Such a situation wouldtemporarily cause a drop in the share prices of steel stocks in the equity

market.

This example is to describe to you how logical the sequence of events is andwhat the end result would be. However, this sequence does take a longduration of time to unfold, sometimes may even take years.


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SETTING THE INVESTMENT OBJECTIVE

The first step for the investor is to set the investment objective.Which would vary for individuals, pension and mutual funds, banks,financial institutions, insurance companies, etc?

For instance the objective for a pension or mutual fund or insurancecompany maybe to have a cash flow specification to satisfy liabilities atdifferent dates in the future. These liabilities would include redemption,dividends or claim settlement payouts.

For a bank it maybe to lock in a minimum interest spread over their cost offunds.

For the individual investor the objective maybe to maximize return oninvestment. A more appropriate word would be 'optimize'. As the individualwould achieve optimum return at optimum risk. To maximize return would

imply the maximization of risk, which would not be practical or sustainable.

It would be quite in order to present a sample investment objective forfurther analysis and modification to suit the requirements of individualinvestors. The objective would revolve around aspects of income generation,growth of the investment capital, stability and implementation.

Sample Investment Objective:

Income: In the year 20XX-XX, I need an income of (state the amount here). In the year 20XX-XX, I need an income of (state the amount here).


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Growth:

In the year 20XX-XX, I need an investment capital growth of (statethe amount here).

In the year 20XX-XX, I need an investment capital growth of (statethe amount here).

Stability:

Maintain a reduced factor of risk to achieve an optimum level ofreturn.

Implementation:

Risk control tools to reduce risk exposure at all times. Money management tools to ensure better flow of funds between the

various asset classes. Document all transactions for future analysis, income review and

taxation purposes.

At the time of the documentation and setting of the investment objective, theinvestor would be called upon to conduct a SWOT analysis to get a better

perspective of his present financial condition and the strengths, weaknesses,opportunities and threats he is faced with. Aspects to consider would be aslisted below:

Sample SWOT Analysis:

Strengths:

Whether he is living in own home/house. Whether he owns office space (may even be generating rental

income). Whether the investment knowledge base is available. Whether the investment system, management process, and platform

are available. Whether the investment capital is available.


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Others; list them.

Weaknesses:

Level of risk tolerance; would be a weakness if it is high. Level of money management skills.

Whether there is enough income generation through presentinvestments.

Whether there is a current expenses overrun. Others; list them.

Opportunities:

Whether there is potential for growth. Others; list them.

Threats:

Inflation risk. Interest rate risk. Conduct and actions of the peer group and extended family which

may cause financial damage or harm. Others; list them.

Of course, the investor is welcome to list other strengths, weaknesses,opportunities and threats he may be faced with or even expects to be facedwith sometime in the future. The purpose here would be to reinforce and/orincrease the strengths and opportunities while restricting and/or reducing theweaknesses and threats.

The next step would be for the investor to document his risk tolerance. Asample would be as stated below:

Sample Risk Tolerance Review:

I have been through the stock market crash of 20XX-XX. Amongst thereasons for coming out relatively unscathed is that I did not sell any stock


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positions. However, during the up-move I sold stock positions at a reducedlevel of profit and also at break even points. This has resulted in a reducedlevel of income generation and investment capital growth; causing anerosion of the investment capital on account of current expenses andcontingency provisioning.

Having learnt good lessons over the years, I have concluded that it would be prudent to reduce the risk tolerance levels from high to medium. This wouldrequire me to follow the investment systems and processes already knownand adopt a more disciplined manner of addressing the stock market.

Thereafter, it would be quite in order to state the investment time horizon. Itwould be prudent to restrict the time horizon to one year at a time; alongwith a periodic performance review during and at the end of the investmenttime horizon. This would be for the primary purpose of improving

performance over the subsequent years.

Sample Investment Time Horizon:

The present investment time horizon is for a period of one year; which isJanuary 20XX to December 20XX. This would see me go through four

quarters; which are January March, April June, July September andOctober December.

Last but not the least, the investor must state and document the matters thatwould require his attention in the future. Some such matters are listed below:

Matters for attention in the future:

Build human capital and knowledge base.

Life and disability insurance. Investment in real estate (residential and office space). Children education and resource allocation. Financial security for the family. Savings for retirement. Wealth creation.


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Charitable activity. Others; list them.

As a word of caution and a disclaimer of sorts, the investor must appreciate

that the above documented sample investment objective, is but a sample.The investor would be required to document his own investment objective;and subsequently analyze and appreciate whether he has been able toachieve such investment objectives. It would be fair to say that the setting of,monitoring; and subsequent analysis and revalidation of the investmentobjective against real time investment results is a dynamic process.


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THE INVESTMENT MANAGEMENT PROCESS

The starting point would be an understanding of theinvestment management process. This process has 5 steps:

SETTING THE INVESTMENT OBJECTIVE:

The first step for the investor is to set the investment objective. Whichwould vary for individuals, pension and mutual funds, banks, financialinstitutions, insurance companies, etc? For instance the objective for a

pension or mutual fund or insurance company maybe to have a cash flowspecification to satisfy liabilities at different dates in the future. Theseliabilities would include redemption, dividends or claim settlement payouts.For a bank it maybe to lock in a minimum interest spread over their cost offunds. For the individual investor the objective maybe to maximize return oninvestment. A more appropriate word would be 'optimize'. As the individualwould achieve optimum return at optimum risk. To maximize return would

imply the maximization of risk, which would not be practical or sustainable.

ESTABLISHING INVESTMENT POLICY:

Establishing or setting investment policy begins with asset allocationamongst the major asset classes available in the capital market. Which rangefrom equities, debt, fixed income securities, real estate, foreign securities tocurrencies. This may also be understood as the establishing of investment

policy begins with the allocation of the financial resource amongst the majorasset classes available in the capital market. Which range from equities,debt, fixed income securities, real estate, foreign securities and currencies,commodities, amongst others.
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SELECTING THE PORTFOLIO STRATEGY:

The portfolio strategy selected would have to be in conformity with boththe investment objective and investment policy guidelines. Any

contradiction here would result in a systems break down and losses.Portfolio strategies are mainly of two types; which are active portfoliostrategies and passive portfolio strategies. Portfolio strategies are mainly oftwo types; which are active portfolio strategies and passive portfoliostrategies. Active strategies have a higher expectation about the factors thatare expected to influence the performance of the asset classes. While passivestrategies involve a minimum expectation input.

SELECTING THE ASSETS:

It is of importance for the investor to select specific assets to be includedin the portfolio. It is here that the investor or manager attempts to constructan optimal or efficient portfolio. Which would give the expected return for agiven level of risk, or the lowest risk for a given expected return.

MEASURING AND EVALUATING PERFORMANCE:

This step would involve the measuring and evaluating of portfolio performance relative to a realistic benchmark. We would measure portfolio performance in both absolute and relative terms, against a predetermined,realistic and achievable benchmark. Further, we would evaluate the portfolio

performance relative to the objective and other predetermined performance parameters. The investor or manager would consider two main aspects;namely risk and return. He would measure and evaluate, whether the returnswere worth the risk, or whether the risk was worth the return. The issue hereis, whether the portfolio has achieved commensurate returns, given the riskexposure of the portfolio.

Ladies and gentlemen, let us assure you that the 5 steps of the investmentmanagement process are applicable to anyone wanting to invest. Of course,you would find a further discussion on each of these steps on the webpageslinked through from the titles of the 5 steps listed above.
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Different Types of Investors

According to him, there are two main types of investors: Average Investorsand Professional Investors.

Average investors buy packaged securities such as mutual funds, treasury bills, or real-estate-investment trusts.

Professional investors are more aggressive they create investmentopportunities or get in on the ground floor of new offerings, build businessesand marketing networks, assemble groups of financiers to fund deals too

large for them to undertake alone, and pick the companies with the most promise for initial public offerings of stock.

There are five different types of professional investors :

The Accredited Investor:

As defined by Robert Kiyosaki, accredited investors are individual investorthat earns at least $200,000 in annual income ($300,000 for a couple) and/orhas a net worth of $1 million. An accredited investor has access to manylucrative investments that, because of their risk may be legally off-limits to

people of lesser income. Although usually financially educated, accredited

investors are not necessarily fully literate. They may be content with securityand comfort rather than wealth, and may rely on advisors to develop andimplement their financial plans.


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The Qualified Investor:

This investor is well versed in either fundamental or technical investing andso there are two types of qualified investors the fundamental investor

and technical investor .

Fundamental investing requires the ability to assess a com panys potential by reviewing financial statements, tracking the industry the companyrepresents, and calculating how changes in interest rates and the economy asa whole could affect profitability. The fundamental investor uses financialratios, which you ll learn all about later, to assess the strength of a companyhe or she is considering as an investment.

Technical investing is different it is based on knowledge of the saleshistory of a companys stock, the mood of the market in general, andtechniques such as short selling and options. The fundamental investor istypically an S in the CASHFLOW Quadrant because he or she will usuallyoperate alone in evaluating stocks, either through examining fundamentalsor using technical analysis in evaluating potential investments.

Unlike a fundamental investor, a technical investor (often a stock trader)

does not necessarily look for well-run, profitable corporations. If people arerushing to invest in a certain type of industry, say dot-com companies, thetechnical investor may jump on the bandwagon, regardless of whether thesecompanies are showing earnings, let alone profits. Technical investing isthus more speculative than fundamental, but it can yield greater rewards.Regardless of investment style, qualified investors know how to make, or atleast preserve, money in an up or down market.

The Sophisticated Investor:

The goal of this investor is to build wealth by developing a foundation ofassets that can generate high cash returns with minimum payment of taxes.Armed with the three Es education, experience, and excess cash thesophisticated investor takes advantage of tax, corporate, and securities lawsto protect capital and maximize earnings. When operating from the B


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quadrant, the investor can choose the best structure or entity through whichto create assets. This entity provides some degree of control over theinvestment and also serves as a firewall between personal and businessfinances in the event of a lawsuit.

Sophisticated investors exercise control over the timing of taxes and thecharacter of their income. They know, for example, to defer paying taxes oncapital gains from real estate by rolling over profits to more expensive

property. They look at economic downturn as an opportunity to pay bargain basement prices for quality securities, and they create deals instead ofsimply waiting for the right one to come along.

Sophisticated investors take risks but abhor gambling, hate losing but are notafraid to, are financially intelligent yet rely on experts to teach them more,own little in their names yet command great wealth. Although they become

partners in real-estate ventures and large shareholders in corporations, theylack one essential strength: management control over their assets.

The Inside Investor:

Building or owning a profitable business is the primary goal of this investor.

Whether as an officer of a corporation or owner of a majority of its shares ofstock, the inside investor exercises some degree of management control. Byrunning business systems from the inside, he or she learns how to analyzethem from the outside and thereby becomes a sophisticated investor as well.Although inside investors have financial intelligence, they do not necessarilyhave financial resources and thus may not meet the definition of anaccredited investor. If inside investors mind their own business and succeed,however, they can become not only accredited investors but ultimateinvestors as well.

The Ultimate Investor :

The goal of the ultimate investor is to own a business that is so successfulthat shares are sold to the public. Making an initial public offering (IPO) isexpensive and full of risks, yet it allows business owners to cash in on the


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equity they have built up in the company, while also raising money to paydown debt and fund expansions. The ultimate investor is one who hasmastered every rule and enjoys playing the game for its own sake.

Which type of investor do you belong? As for me, I am not even a professional investor. I am just an average investor. But with the continuouslearnings that I feed my mind, I hope to become a professional investorsomeday and be able to reach the ultimate investor status.


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INVESTMENT AVENUES

There are a large number of investment instruments available today. Tomake our lives easier we would classify or group them under 4 maintypes of investment avenues. We shall name and briefly describe them.

1.Financial securities: These investment instruments are freely tradable andnegotiable. These would include equity shares, preference shares,convertible debentures, non-convertible debentures, public sector bonds,savings certificates, gilt-edged securities and money market securities.

2. Non-securitized financial securities: These investment instruments are nottradable, transferable nor negotiable. And would include bank deposits, postoffice deposits, company fixed deposits, provident fund schemes, nationalsavings schemes and life insurance.

3. Mutual fund schemes: If an investor does not directly want to invest in the

markets, he/she could buy units/shares in a mutual fund scheme. Theseschemes are mainly growth (or equity) oriented, income (or debt) oriented or

balanced (i.e. both growth and debt) schemes.

4. Real assets: Real assets are physical investments, which wouldinclude real estate , gold & silver, precious stones, rare coins & stamps andart objects.

Before choosing the avenue for investment the investor would probably

want to evaluate and compare them. This would also help him in creating awell diversified portfolio, which is both maintainable and manageable.
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INVESTMENT ATTRIBUTES

To enable the evaluation and a reasonable comparison of variousinvestment avenues, the investor should study the following attributes:

1. Rate of return

2. Risk

3. Marketability

4. Taxes

5. Convenience

Each of these attributes of investment avenues is briefly described andexplained below.

1. Rate of return: The rate of return on any investment comprises of 2 parts,namely the annual income and the capital gain or loss. To simplify it furtherlook below:

Rate of return = Annual income + (Ending price - Beginning price) /Beginning price

The rate of return on various investment avenues would vary widely.

2. Risk: The risk of an investment refers to the variability of the rate ofreturn. To explain further, it is the deviation of the outcome of an investmentfrom its expected value. A further study can be done with the help ofvariance, standard deviation and beta.

3. Marketability: It is desirable that an investment instrument be marketable,the higher the marketability the better it is for the investor. An investmentinstrument is considered to be highly marketable when:

It can be transacted quickly.


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The transaction cost (including brokerage and other charges) is low.

The price change between 2 transactions is negligible.

Shares of large, well-established companies in the equity market are highlymarketable. While shares of small and unknown companies have lowmarketability.

To gauge the marketability of other financial instruments like provident fund(which in itself is non-marketable). Then we would consider other factorslike, can we make a substantial withdrawal without much penalty, or can wetake a loan against the accumulated balance at an interest rate not muchhigher than our earning rate of interest on the provident fund account.

4. Taxes: Some of our investments would provide us with tax benefits whileother would not. This would also be kept in mind when choosing theinvestment avenue. Tax benefits are mainly of 3 types:

Initial tax benefits. This is the tax gain at the time of making the investment,like life insurance.

Continuing tax benefit. Is the tax benefit gained on the periodic return fromthe investment, such as dividends.

Terminal tax benefit. This is the tax relief the investor gains when heliquidates the investment. For example, a withdrawal from a provident fundaccount is not taxable.

5. Convenience: Here we are talking about the ease with which aninvestment can be made and managed. The degree of convenience wouldvary from one investment instrument to the other.


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COMPARISON OF INVESTMENT AVENUES

Rate of returnAnnual Income

Rate ofreturnCapitalAppreciation

Risk Marketability Tax Benefit Con

Financial Securities

Equity Low High High High Yes Hig

Non-convertibleDebentures

High LowLow

Average Nil Hi

Financial securities(Non-securitized)

Bank deposits Low Nil Low High Yes High

Provident fund Nil High Nil Average Yes High

Life insurance Nil High Nil Average Yes High

Mutual fundsGrowth/equity Low High High High Yes High

Income/debt High Low Low High Yes High

Real assets

Real estate Low High Low Low Limited Ave

Gold/silver Nil Average Average Average Nil Aver


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this approach the investor uses some tools of technical analysis, with a viewto study the internal market data, towards developing trading rules to make

profits.

In technical analysis the basic premise is that price movement of stocks havecertain persistent and recurring patterns, which can be derived from markettrading data. Technical analysts use many tools like bar charts, point andfigure charts, moving average analysis, market breadth analysis amongstothers.

Academic approach: Over the years, the academics have studied manyaspects of the securities market and have developed advanced methods ofanalysis. The basic rules are:

The stock markets are efficient and react rationally and fast to theinformation flow over time. So, the current market price would reflect itsintrinsic value at all times. This would mean "Current market price =Intrinsic value".

Stock prices behave in a random fashion and successive price changes areindependent of each other. Thus, present price behavior can not predict

future price behavior.

In the securities market there is a positive and linear relationship betweenrisk and return. That is the expected return from a security has a linearrelationship with the systemic or non-diversifiable risk of the market.

Eclectic approach: This approach draws upon all the 3 approaches discussedabove. The basic rules of this approach are:

1. Fundamental analysis would help us in establishing standards and benchmarks.

2. Technical analysis would help us gauge the current investor mood and therelative strength of demand and supply.


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3. The market is neither well ordered nor speculative. The market hasimperfections, but reacts reasonably well to the flow of information.Although some securities would be mispriced, there is a positive correlation

between risk and return.


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COMMON ERRORS IN INVESTMENT MANAGEMENT

In any endeavor we undertake, we are sometimes right and makecorrect decisions and sometimes we are wrong and prone to errors. Weare prone to these errors, when we do not have a correct perspective ofthe environment or lack a correct assessment of the current situation inthe environment.

We would have to watch out for these errors to reduce the probability oflosses. For instance, it would be very difficult and an error to be in a buy orhold position if the market is in a bearish mode. Similarly, it would bedifficult and an error to be in a sell or short position if the market is in a

bullish trend. It would be advisable, correct and profitable to trade with thetrend and not against it.

Still investors of all hues and levels of experience are prone to errors. Someof these errors are listed and described below:

Goals beyond rational expectation: Here the investor probably thinks that heowns the company lock, stock and barrel. Or that the market owes him his

profits for having exposed himself to the market risks. Or the investor mayhave a targeted expected rate of return beyond what the market would beable to give him consistently over time.

On the other hand, unrealistic goals could also be a result of unjustifiedclaims made by a company going for a new issue. Or misplaced expectationsdue to exceptionally good past performance of the investment instrument ora mutual fund or a portfolio manager. Or promises not kept by tipsters,market operators and fly by night operators.

An investment policy not clearly defined: This would also include an unclearview on risk. Here, the investor would be prone to greed and fear as the


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market goes up and down, respectively. This vacillation would cause theinvestor much loss and pain.

Seat of the pant decision making: Investors without even realizing it base

their decisions on incomplete information. Some of the thoughts of theinvestor would be:

Come on! I know what is going on in the market, and there isn't any time todo a detailed analysis. I don't want an opportunity loss if I delay.

All that hard work is strictly for the mediocre. I know I am right.

He is my guru and can't be wrong.

We must clarify at the beginning whether we are doing an investmentexercise or are we indulging in ego satisfaction. If it is investment then dothe analysis as the markets and the investment instruments will still be theretomorrow. On the other hand, if it is ego satisfaction, then may the Gods

bless you, as other would profit from your market actions.

Another situation could cause the investor a loss of balance. As the marketgoes up and continues going up, the investor tends to set aside all thoughtson the various investment risks and follows the investing public. Here, theinvestor is being greedy, and sooner or later would pay the price for thiserror of judgment.

Stock switching: In this situation, the investor is selling one stock and at thesame time buying another stock. This is interesting, as here the investorexpects that the first stock would go down in value, while the second stockwould go up. This is unique and is rarely successful.

Two scenarios require our attention:

It maybe the right time to sell the first stock, but it may not be the right timeto buy the second stock, as that too maybe on its way down.


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It maybe the right time to buy the second stock, but it may not be the righttime to sell the first stock, as it may still have some upside left.

The love for a cheap stock: A cheap stock is a very attractive proposition for

any investor, as he is able to buy large quantities of the same. Investors findit easier to buy 1,000 shares of a INR 10.00 stock, and find it difficult to buy100 shares of a INR 100.00 stock. The total investment amount is the samein both cases.

In certain situations, when a stock price moves down, investors start buyingand continue to buy larger quantities of the same stock. The investor here isaveraging his price down. But, he does not have a guarantee that in theforeseeable future the price trend of this stock would reverse and go abovehis average purchase price. Averaging can be dangerous.

Over-diversification: Is a situation, when an investor has a large number ofnames in his portfolio, maybe 50 or 60 or even more.

Let's be practical, it is like owning an index and more. Therefore theinvestor's portfolio performance would be about the same as the index ormarginally above or below it depending on the names in the portfolio.

Secondly, managing and monitoring would become a Herculean task. Theinvestor would get a false sense of safety in numbers. Decision-makingwould become slow and ineffective. If the market goes down due to asystemic risk factor, all the stocks including the best would move down in

price. And the investor would not know what to sell, at what price to sell andwhen to sell.

Ideally, a portfolio should consist of 10-15 well-researched stocks. In any

case as individual investors we are not institutions, nor do we have therequisite staffing to effectively monitor and manage a larger number ofstocks.

Under-diversification: Is a situation in which an investor has only 1-2 stocksin his portfolio. This maybe due to a situation of over-confidence in the


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expected performance of these stocks. Or maybe the result of plaincomplacency.

This is not a good portfolio strategy, as the investor has exposed himself to

all market risks to a larger extent due to a lack of diversification. We mustalways remember that we diversify our portfolio to minimize the systemic ornon-diversifiable risks. In any case, this high level of risk exposure is notreally necessary if we view ourselves as long term investors.

The lure of known companies: Investors are tempted to buy shares ofcompanies that they know and are familiar with. However, the investorshould keep in mind, that his knowing a company is not correlated to thereturns he expects to derive from his investments in its stock.

Wrong attitude towards profits and losses: An average investor due to egoand pride does not want to recognize or admit that he may have made amistake. Let's look at two situations:

An investor buys a stock, and soon thereafter its price goes down. Instead ofapplying a stop loss and getting out of the stock, the investor holds the stockin expectation of a rebound or trend reversal. However, the price continues

moving down with a potential of a further decline. Now, the investor isholding the stock at a 30%-40% loss. Here, the investor wants to postponethe booking of this substantial loss and the acknowledgement of havingmade a mistake.

When the stock price does move up, the investor is ready and waiting to sellthis stock at or marginally above his purchase price, even if the stock isexpected to move up into a higher trading range. Here the investor sells togain the relief of not having incurred a substantial loss and also he does nothave to acknowledge his mistake at the start of this investment. Both thesesituations are loaded towards the reinforcement of losses and not profits.


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INVESTMENT AND SPECULATION

There is a very thin and blurred line between investing and speculating(or gambling). To have a clearer understanding of this, we would

differentiate between the two.

There is a tendency for investors to be speculative when the markets are bullish and buoyant. However, for long term and profitable survival in themarkets we must try and control this urge to speculate. After all, we are hereto learn and apply investment management and not speculation management.

To be part of the speculative herd in a bull market situation has been thewaterloo of many participants in the financial markets across the globe. This

participant maybe an individual investor, a NBFC, a financial institution, a pension fund, a bank, or a brokerage. Some are responsible corporatecitizens while others are not.

Investor Speculator

Planning horizon Relatively long, holding periodof at least 1 year.

Very short, holding period a fewdays or weeks.

Risk disposition Moderate, rarely high risk. Normal to assume high risk.

Return expectation Moderate returns at limited

risk.

High return at high risk exposure.

Basis for decisions Fundamental factors, carefulevaluation of proposedinvestment.

Relies on hearsay, tips and market psychology.


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With regard to the differentiation between investors and speculators listedabove it would be opportune to elaborate on these points of reference. We

would first explain the investor's position and mindset; thereafter, we wouldexplain the speculator's views in this regard.

Planning horizon: The investor would be willing to buy and hold stock positions for long periods of time and probably well beyond the 1 year listedabove. This would mostly be the result of the investor having preparedhimself both financial as well as psychologically for the inevitable changesin the prices of the stocks held in his stock portfolio. His intention would beto benefit from the advances in the value of his stocks at various levels of themarket; in other words it is highly probable that most of his stock positionswould turn out to be multi-baggers by the time he sells them. In a sense hewould buy these stocks at prices which offer a fair discount over value tohim; in other words he would be "buying low and selling high". Even if hisintent were to indulge the short term on occasion, it would be with the fullknowledge that he is now speculating.

The speculator on the other hand is seeking immediate gratification. Thus,

he would trade within the day while buying some stocks and selling themlater at the rise of a few points and selling other stocks and buying them

back after a fall of a few points. Usually, the speculators would be inmoment to moment contact with the trade desk of their broker. They are ofthe view that the life cycle of the earning capacity and capability of theselected stocks and their underlying enterprise can be replicated within thespan of a trading day. This is also called day trading. The speculators mayindulge margin trading and on occasion even the futures & options segment

of the stock market to leverage their meagre financial resources.Risk disposition: The investor would at all times seek a discount to theintrinsic value of the stocks he would buy subsequently for capital gainssometime in the future. For instance, he would seek stocks priced at levels ator below their book value per share; of course, the earnings per share would

be at reasonable levels and maintainable into the future and the price earning


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multiplier would be at a lower level when compared with other similarstocks. Thus, the investor would need to wait while the stock price gains tolevels at or above its book value per share and sell the stock at a reasonable

profit. This price range may on occasion be the first point of profit; anddepending on the future performance and outlook of the underlyingenterprise the investor may find occasion to buy the stock again at higher

price levels (including after a downward price correction from the recenthigher price levels) and subsequently sell them at even higher levels. In thisfashion and style the investor would be able to considerably reduce his riskexposure.

The speculator would be willing to take on a higher level of risk in

expectation of a higher return in the short term. As his holding period is veryshort he is able to take on larger stock positions probably on margin. Butgiven the short duration of his holding period he is unable to mitigate therisk in any fashion and style and the moment to moment stock price duringthe day (or a few days or weeks) would guide the decision to sell the stock atthe gain of a few points during the day or a few percentage points during theweek. On the flip side, if the stock price were to move against thespeculator's position he would need to quickly sell it to minimize the loss. Itwould be the stock price which would rule the trading decisions.

Return expectation: The investor as already listed above would expectmoderate returns from his stock market investments as he would be limitinghis risk exposure to acceptable and reduced levels. However, the discerninginvestor with many years of experience would be able to compound hisinvestment capital at a reasonable rate over the years of his investment timehorizon. On average such compounding would be at 16% to 18% annualizedand on occasion may be at levels of 50% and even more.

The speculator on the other hand would adopt a higher level of risk exposurein the expectation of a higher return in the short term. As such decisions aremostly based on the daily price volume data pertaining to the stocks selectedfor trading, they would not take into account the unsystemic risk associatedwith these stocks or the systemic risks associated with the stock market in


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general. If the speculator is right he has gains to be had, and if he is wronghe would have to book the loss and move on to the next trade. On mostoccasions it would be a zero sum game, as he would win some and also losesome.

Basis for decisions: The investor would consider the fundamental factorseasily found in the balance sheet, profit & loss account and cash flowstatements of the underlying enterprise. This study would revolve around the

profit after tax which is also the earnings per share, dividends paid, and the present premium over earnings afforded by the current market price which isalso called the price earnings multiplier. This study on most occasions wouldalso expand into an understanding of the products and services of the

enterprise, its plant locations, its markets and its relative position in suchmarkets. To complete this study would require the investor to also gainknowledge of the management and an understanding of their managementstyle. This evaluation of the stock would be in the lines of enabling partminority ownership in such enterprise for the investor.

The speculator would give little regard to an evaluation of the fundamentalsunderlying a stock. His trading decisions would be based mostly on tips,grapevine news and hearsay. It would indeed be market psychology at playas its the present price trend that is being addressed. His decision would bemostly based on the here and now with little or no regard to the future

prospects of the underlying enterprise.

It would surprise most to learn that in today's time and age the speculatorsusually call themselves short-term investors, probably in an attempt to bringrecognition and dignity to their trade and craft. Indeed this would blur thedistinction between investors and speculators even further; as the investors

would now be the long-term investors while the speculators would be theshort-term investors.


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What is the Difference Between Gambling and Investment

What is the difference between gambling and investing? In order todifferentiate between the two, we should start by defining them.Comparisons are often made between the two activities, but Ive never seenthe terms explicitly defined. If youre sufficiently motivated, I encourageyou to try to define the terms gambling and investing before you continuereading this essay you may surprise yourself.

What definitions did you come up with? Are investing and gamblingmutually exclusive, or is there an area of overlap? And are the boundariesclearly delineated, or is there a gray area in the middle?

Lets see what the dictionary says. Heres what the Random Housedictionary on my bookshelf says:

Gamble: To play at any game of chance for stakes. To stake or risk money,or anything of value, on the outcome of something involving chance.

Invest: To put money to use, by purchase or expenditure, in somethingoffering profitable returns.

Both seem reasonable upon cursory review, but a closer look reveals thattheyre not terribly helpful. The definition for gambling could apply just aswell to investing, and vice-versa.

The Dictionary.com web site says:


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Gamble: To bet on an uncertain outcome, as o f a contest. To take a risk inthe hope of gaining an advantage or a benefit.

Invest: To commit money or capital in order to gain a financial return.

Again, the distinction isnt clear. In investing, are you not betting on anuncertain outcome? Are you not taking a risk in the hope of gaining anadvantage or benefit? In gambling, are you not committing money? Are younot doing it in order to gain a financial return?

I nvesting is a good thi ng, gambli ng i s a bad thing.

I think it would be hard to argue with the claim that investing is, on the balance, a good thing. Investing is widely regarded as the engine that drivescapitalism. It tends to put money in the hands of those with the most

promising and productive uses for it, and drives the economy graduallyupward. Investors arent merely betting on which companies will succeed,theyre providing the capital those companies need to accomplish theirgoals. The U.S.s leadership position in technology is largely due toinvestments by venture capital firms, angel investors and technophilicindividual investors. Similarly, you can change the world in a small way byinvesting in companies you believe in, such as socially or environmentallyconscious firms and mutual funds, or biotech companies that are working ondiseases that might affect you or someone close to you.

Gambling, on the other hand, is not so clearly making a positivecontribution. Gambling does tend to help local economies, but also usually

brings with it well- documented unpleasant side effects. Il l leave it up to thereader to decide whether gambling is, on the balance, a plus or a minus.

Looking to the financial markets, one could make the case that people whogamble in this realm do serve a function, by adding to the markets depth,liquidity, tr ansparency, and efficiency. But thats of relatively minor value,and those gamblers probably capture most of that value for themselves. Onthe other hand, they often increase the volatility of the markets, which is on


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the balance usually a negative (although it does afford savvy investorsopportunities for larger profits). As Warren Buffett has said,

Wall Street likes to characterize the proliferation of frenzied financial

games as a sophisticated, prosocial activity, facilitating the fine-tuning of acomplex economy. But the truth is otherwise: Short-term transactionsfrequently act as an invisible foot, kicking society in the shins.

The questions of whether gambling is morally wrong and how strictly itshould be regulated are important but are well beyond the scope of thisessay, and so Ill mention them only in passing. Governments generallyfrown on gambling (unless, of course, theyre getting the lions share of the

profits, such as with state lotteries). Many religions frown on gambling (butthey do nt seem to mind church bingo). I have no problem with a person

being morally opposed to gambling, as long as that person knows exactlywhat he/she means by gambling.

I should hasten to add that not all types of investing are productive. Buyingand holding results in a positive contribution to the economy, but buying andselling quickly, the way day traders do, results in no net contribution. For the

purposes of the current investigation, we could either reclassify investing-type activities that arent productive as gambling, or we could consider theseto be exceptions to the rule. I lean toward the latter interpretation.

I n in vestin g, the odds are in your favor; in gambli ng, the odds are againstyou.

Peter Lynch has said that

An investment is simply a gamble in which youve managed to tilt the odds

in your favor. But that position is too simplistic. There are plenty of investments where theodds are against you: futures, options, and commodities trading (where youget hurt on commissions and the bid/ask spread), frequent stock trading (forthe same reason), and selling short (since the market goes up rather thandown in the long run), to name just a few examples. Similarly, while for
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most types of gambling the odds are against you, it is possible for the oddsto be in your favor. I spent one summer during college working in Arizona,and I drove up to Nevada most weekends to play blackjack. By countingcards, I was able to obtain a small but predictable advantage over the house,about 1.5% per betting unit on average. (I havent returned since then, forseveral reasons: its not intellectually challenging; while card counting i s notillegal, Vegas casinos can make you leave if they suspect you of doing it;and Ive found it easier and more enjoyable to make money in stocks than in

blackjack.) Expert poker players can also make money at casinos, becausetheir competition is other players rather than the house, and as long as thehouse takes its cut it doesnt care how the rest of the money is redistributedamong the players.

There are additional problems with this attempted characterization ofgambling as a losing bet and investing as a winning bet. It implies that agiven activity switches from gambling to investing (or vice versa) as soon asthe odds swing past the breakeven point. Similarly, if two players are

participating in an activity in which one has an advantage over the other, itwould mean that one person is gambling and the other is investing. Thatwould imply that institutions which get in on IPOs at the offering pricewould be investors, and the little folks that those institutions immediatelyflip the shares to for a profit would be gamblers. Furthermore, while its

possible to calculate exact odds for some casino games, this is rarely thecase on Wall Street. How can you know for sure whether the odds are for oragainst you if you decide to buy a particular stock today?

What about venture capital investments, you say? Arent the odds stackedagainst them? Yes, the majority of venture capital investments result in loss,often a total loss of the amount invested. However, venture funds typically

yield higher returns than stocks because a small percentage of the firmsinvestments are home runs, more than making up for complete losses onother investments. So while venture capital might seem like gambling in thatthe odds are against the VC firms on any given bet, on average the expected

payoff is positive, so the odds in the long run are actually in their favor.


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Gambling can be addictive and destructive, but investing cant.

Compulsive gambling has been correctly identified as a problem, andorganizations like Gamblers Anonymous are helping people cope with the

problem. No similar problem is generally thought to exist in investing. Thereis no Investors Anonymous, and no one talks about compulsive investors.But while there isnt yet widespread acknowledgement of investingaddiction, there will be soon. Marvin Steinberg, executive director of theConnecticut Council on Compulsive Gambling, recently said this aboutinvesting addiction:

We dont know the true extent of the problem because hardly anyoneidentifies it as a gambling problem they see it as a financial problem or

an investing problem. Many online investors who claim to be buy-and-hold investors check their

portfolios on a daily or hourly basis, and jump in and out of stocks moreoften than they realize. Active trading can be expensive, both in terms of thecommissions and bid/ask spreads and in terms of emotional fatigue. Also,some people invest more aggressively than they should, which is virtuallyidentical to gamblers who bet more money than they can afford to lose. This

page provides a list of questions to help a person determine if he/she might

be a compulsive gambler. Replace the word gambler with investor foreach question and the questionnaire is equally useful, but for a different purpose.

I nvesting is saving for specif ic goals, such as reti rement, while gambli ngisnt.

Many people regard investing as a planned strategy of wealth-building forspecific future goals. And this is certainly true of some types of investing.

But this is largely a by- product of having the odds in ones favor. If youhave the edge (whether in blackjack or in equities), time and the laws of probability are a powerful combination. Gambling would work just as wellas investing for financial event planning if gambling games were in yourfavor.
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I nvestors are r isk-averse, whil e gamblers are r isk-seekers.

Risk-taking is intrinsic to both gambling and investing. There are a fewinvestments that dont en tail risk, such as fixed annuities and government

bonds held to maturity, but even those have inflation risk. The majordifference between the two groups seems to be the participants relativewillingness to accept risk. Investors tend to avoid risk unless adequatelycompensated for taking it, but gamblers dont. To put it another way,investors take only the risks they should take, while gamblers also take somerisks they shouldnt take. Would you rather have $50 or a 50/50 chance at$100? If you take the $50, youre an investor. If you go for all or nothing,youre a gambler. Would you rather put your money under your mattress orin an extremely volatile stock that could go bankrupt or could double invalue? The question is slightly different, but the answer is equallyinstructive. If you expect to double your money quickly, whatever youredoing is probably gambling, even if it happens on Wall Street rather than inLas Vegas.

However, this characterization of gamblers as risk-takers applies only tonon-professional gamblers, people who visit Atlantic City for a weekend forentertainment purposes. Professional gamblers who have managed to tip the

odds in their favor behave more like investors, shying away from risk unlessthe reward is sufficient to justify taking the chance. In fact, one could makethe argument that investors generally take on more risk than professionalgamblers, because of the uncertainly inherent in the financial markets. As Imentioned before, its difficult for investors to calculate ho w much of anadvantage they have, but the odds of a given gambling strategy can beknown either precisely or at least approximately.

I nvesting is a conti nuous process; gambling i s an immediate event orseri es of events.

This rule does seem to hold in most cases. Investing is a continuous processof deployment of capital in search of continually increasing net worth. As aresult, delayed gratification is implied. Gambling is a specific act or series ofacts, centered around immediate gratification. In this respect, day trading


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resembles gambling: the participant gets in, the price moves up or down, andhe/she gets out, usually in a matter of minutes. The same could be said of

buying with the belief that a stock is about to jump, or buying IPO shareswith the intention of flipping them in a few hours or days, or buying optionswhich are close to expiration. On the other hand, buying in the belief that astocks price will eventually reflect its value, with the plan of holding aslong as it takes for this to happen, is more like investing.

Investing is the ownership of something tangible; gambling isnt.

The latter half of the statement is certainly true, but the former half is onlysometimes true. Some investments involve the ownership of somethingtangible, but many dont. For example, derivatives are investments derived

from other investments. An option is a derivative that gives the owner theright to buy or sell a specific amount of a given security at a specified priceduring a specified period of time. Options are generally classified asinvesting rather than gambling, and rightly so, but they do not representownership of anything tangible. However, when you realize that an option isessentially a bet that a given security will or wont be above a certain priceon or by a certain date, it starts to feel more like gambling thaAn even morestrict definition of investing would require that it involves the purchase of an

asset which either produces a stream of income or can be made to produce astream of income. But this definition would eliminate such assets ascollectibles, stamps, art, and gold, which have no intrinsic value. I dontthink it makes sense to exclude them simply on this basis. We might choosenot to consider them investments because of their poor long-term

performance, but we shouldnt choose not to consider them investmentssimply because they wont ever produce a stream of income.

I nvesting i s based on ski ll and r equi res the use of a system based onresearch, whi le gambling i s based on l uck and emotions.

A lot of so- called investors dont do nearly as much research as they should.Many buy on tips or rumors, or based on some analysts price target, withoutdoing their own exhaustive research. It feels right to call such behaviorgambling. Similarly, investors who are making decisions based on emotions


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investing- related things but werent behaving like investors, or people whowere doing gambling- related things but werent behaving like gamblers. Ofthe four groups, recreational investors, professional investors, recreationalgamblers, professional gamblers, there are more similarities between the tworecreational groups and between the two professional groups than betweenthe two investing groups and between the two gambling groups.Specifically, those who use a rigorous system, do research, tilt the odds intheir favor, treat it as a business rather than as entertainment, avoidaddiction, and keep their emotions in check tend to behaving like investors,and those who dont tend to be behaving like gamblers. It might not be sucha stretch to call professional gamblers investors and recreational investorsgamblers.


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INVESTMENT WISDOM

Listed below are wisdom one liners which would give an investor aninsight to what he or she is up against:

o The market is a discounting machine.o A cynic knows the price of everything and the value of nothing.o Investment management is 10% inspiration and 90% perspiration.o To err is human, to hedge divine.o No stock is good or bad, it is the price that makes it so.o No price is too high for a bull or too low for a bear.o Somebody is wrong every time a trade is made.o Ride the winners and sell the losers.

o You never understand a stock unless you are long or short in it.o Be long term but watch the ticks.o Never throw good money after bad.o To achieve superior performance, you have to differ from the

majority.o

Two things cause stocks to move, the expected and the unexpected.o No tree grows to the sky.o A pie doesn't grow through its slices.o Never confuse brilliance with a bull market.o Successful investment managers have brains, nerves and luck.o All generalizations are false, including this one.o The market makes mountains out of molehills.o Investigate, then invest.o The memory of people in the stock market is very short.o Open-mindedness and independent thinking will pay big dividends in

the stock market.o It is only a step from the sublime to the ridiculous.o It is only a step from common stock investment to common stock

speculation.


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o The market is a pendulum that swings back and forth through themedian line of rationality.

o The only way to beat the market is to discover and exploit otherinvestors' mistakes.

o No investment manager can perform successfully in all kinds ofmarkets. There is no man for all seasons.

o Better is one forethought than two after.o The greatest of all gifts is the power to estimate things at their true

worth.o Shallow men believe in luck, wise and strong men in cause and effect.


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THE BROKER

As investors we are not able to deal with the market directly. It wouldbe like entering and trying to find our way through an unending maze.The markets on their part, are too large, to attend to every singleinvestor directly. This would be a Herculean task and a managementnightmare for it. So, the markets introduce and authorize themiddleman to act on its behalf. This middleman is also called theBroker.

To reinforce this point, consider the following:

1. We want an insurance policy, we would deal with the insurancecompany's agent.

2. We want to buy a car or motor cycle or scooter, we would deal with thedealer of the automobile manufacturer.

3. We want to buy a pair of trousers or shirt or a dress, we would go to theretail store which sells these products. The retail store would be therepresentatives of various fashion brands.

4. We want to buy the shares of a company traded in the NSE or BSE. Wewould have to deal with the many stock brokers of these exchanges.

Agents, dealers, representatives and brokers mean the same thing, and they perform the same function. Which is that of a middleman. They do thisfunction as they would be receiving commissions in return for the servicesthey provide.

For instance, whether an investor buys or sells a stock in the stock exchangethe middleman or broker would receive a commission either ways. Which isa percentage of the value traded by the investor. The same (that is, the

broker's commission or charges and fees) would also be applicable to


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transactions the investors may undertake in the futures and options segmentof the stock market as well as ETFs (or equity traded funds).

For investors it is very important to choose a broker correctly. Also that the

broker is able to provide the services that the investor requires.

In this selection of a broker, the investor would be well advised to considerthe following:

1. Is the brokerage well established and known in the market?

2. Is the representative of the brokerage house able to attend to him or is heoverloaded with too many accounts?

3. Does the brokerage have a research department. How many qualified professionals do they have on their staff?

There are many other questions, which may be asked and answered. Themain aim here is whether the broker we are proposing to deal with, meets allour requirements or not.

In more recent years, this brokerage function of the stock markets as well as

other financial markets has been engaged by the leading banks through their brokerage subsidiaries. This has indeed brought all market services(including the trading platform and advisory services) and back officesupport to the retail investors at very cost effective fees and charges. Someof the banks and their subsidiaries would be the SBI, HDFC Bank, KotakMahindra Bank, ICICI Bank, amongst other leading banks.

Ideally, an investor may contact these banks with regard to stock marketservices (including the trading platform, advisory services and brokeragefunction) required by them. Similar questions as listed above would again beasked to enable the selection of the best fit bank and its subsidiary for theefficient management of an investor's financial resources (including theinvestment capital he or she may have available for the task of investmentand its management).


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INVESTMENT MANAGEMENT AND TRADING IN THE STOCKMARKET

We realize that this area of our field of endeavor is a serious matter forany investor of the stock market, so it is best to start with the basics. Weexpect that, the investor has an understanding of the various aspects ofinvestment management. Now, we would be introducing the aspect of'trading'.

Trading is basically buying and selling a financial instrument, like a stockquoted in the stock market. And making a profit from the transaction. That isthe investor's selling price is more than the cost price.

To get things into perspective, the stock market does not go straight up orstraight down. It moves in steps. Depending on the information flow it may

move forward (or up) or move back (or down). With research, we haveconcluded that a step is 6.25% of a base price. That is, if the base price of astock is 100.00, then one step is 6.25. This base price is the fair value ofa stock at that point in time.

The stock market over a period of time would show the following conditionsor phases:

Bull phase. Where the equities traded in the stock market are taking at least

2 steps forward with one step back. This may extend to 6 steps forward to 2steps back. In further extreme conditions there would be no top to the stockmarket.

Bear phase. Where the equities traded in the stock market take 2 steps backfor every one step forward. This may extend to 6 steps back to 2 steps


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forward. In further extreme conditions there would be no bottom to the stockmarket.

Consolidation phase. Where the stocks traded in the stock market have

reached an equilibrium level and are taking one step forward for every onestep back. However, the various participants of the stock market are awaitingsome news to take the price up or down depending on the nature of thenews. That is whether the news is as per expectation, better than expectationor not as per expectation and what effect it has on the valuation of the stockin question. Thereafter we can expect a further move in the price levels.

Distribution phase. Where the stocks traded in the stock market haveachieved high price levels maybe their yearly highs. It is here that the stronghands (knowledgeable investors) are selling equities to the weak hands (notso knowledgeable investors). After the selling is over and done with, wemay safely expect a down move in price levels. That is, prices would movedown and back to their fair values or below it. Let's face it, whichknowledgeable investor would buy stocks when he knows that there is nomargin of safety available in the transaction.

Please remember, whichever phase the market may exist in, it is taking one

step at a time. However, depending on the nature of the stage the marketmay take more than one step in a day. This would cause happiness toinvestors if the net outcome is positive and sadness if the net outcome isnegative.

We have provided links to various webpages of our website which would berelevant to this aspect of investment management. It is expected that theinvestors after read these webpages listed below would have a betterunderstanding of the stock markets, the preparation they must do beforeengaging it in a better than amateur fashion. It may also be understood that,in spite of all the knowledge and wisdom the investors may gain with regardto investment management at the various stages of their learning curve, thestock markets would still do what they must do; so, caution would beadvisable at all the various stages of the investment program the investorsmay implement from time to time.


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Conclusions

So whats my resolution to this definition conundrum? Well, the purpose ofwords is to communicate concepts. So it doesnt really matter whatdefinitions you use, as long as you and But with that said, it would be

beneficial if everyone could agree on what the terms mean, so we dont nee dto make our definitions explicit every time we want to use them. To this end,I offer the following definitions, which are built from the variouscharacterizations in the above section:

Investing:

Any activity in which money is put at risk for the purpo se of making a profit, and which is characterized by some or most of the following (inapproximately descending order of importance): sufficient research has beenconducted; the odds are favorable; the behavior is risk-averse; a systematicapproach is being taken; emotions such as greed and fear play no role; theactivity is ongoing and done as part of a long-term plan; the activity is notmotivated solely by entertainment or compulsion; ownership of somethingtangible is involved; a net positive economic e ffect results.

The person(s) youre communicating with are clear about what is meant bythose words. And even more importantly, as long as you know what youredoing, investing or gambling, before you do it.

GamblingAny activity in which money is put at risk for the purpose of making a

profit, and which is characterized by some or most of the following (inapproximately descending order of importance): little or no research has

been conducted; the odds are unfavorable; the behavior is risk-seeking; anunsystematic approach is being taken; emotions such as greed and fear playa role; the activity is a discrete event or series of discrete events not done as

part of a long-term plan; the activity is significantly motivated by


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entertainment or compulsion; ownership of something tangible is notinvolved; no net economic effect results.

Speculating I would prefer to avoid this term entirely, but if necessary Iwould define it as:

Are you disappointed that I didnt crystallize the essence of gambling andinvesting into a single distinguishing feature? Did I merely sidestep theambiguity, and sweep the gray areas and the important exceptions under therug? I dont think so. The taxonomy doesnt have to be completely distinctin order to be useful, nor does it need to be just a single feature. And just

because some of the characterizations had exceptions doesnt mean they

should be thrown out entirely. Nearly everyone agrees that the concept ofchair is a useful one, even though its difficult to define exa ctly what thenecessary and sufficient characteristics of a chair are.

investment enviornment

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