Investment Attributes

April 3, 2018 | Author: Niranjan Phuyal | Category: Technical Analysis, Investing, Market Liquidity, Investor, Risk



Investment AttributesSince there is much at stake in an investment decision, an investor should consider the basic attributes of investments when deciding on a suitable option. At least four investment attributes are integral to sound decisions in this sphere: ♦ Safety : Although the degree of risk varies across investment types, all investments bear risk. Therefore, it is important to determine how much risk is involved in an investment. The average performance of an investment normally provides a good indicator. However, past performance is merely a guide to future performance - not a guarantee. Some investments, like variable annuities, may have a safety net while others expose the investor to comprehensive losses in the event of failure. Investors should also consider whether they could manage the safety risk associated with an investment financially and psychologically. ♦ Rate of return: Investments (growth options) generally provide higher rates of return compared to other asset classes - cash and income options. The rate of return compensates for the level of risk involved. Therefore, higher risk investments should necessarily bear higher rates of return to attract investors. It is important not to be preoccupied with the rate of return without assessing its relation to safety. ♦ Liquidity: A liquid investment is one you can easily convert to cash or cash equivalents. In other words, a liquid investment is tradable- there are ample buyers and sellers on the market for a liquid investment. An example of a liquid investment is currency trading. When you trade currencies, there is always someone willing to buy when you want to sell and vice versa. With other investments, like stock options, you may hold an illiquid asset at various points in your investment horizon. ♦ Duration: The duration of an investment-, particularly how long it may take to generate a healthy rate of return- is a vital consideration for an investor. The investment horizon should match the period that your funds must be invested for or how long it would take to generate a desired return. Investment Objectives: 1. 2. 3. 4. 5. 6. Capital Appreciation Current yield Reduce risk Hold the company Create a portfolio Speculation No risk-return trade-off. Fundamental approach: In this approach the investor is concerned with the intrinsic value of the investment instrument. All investment strategies can be broadly classified under 4 approaches. Negative outcomes are expected. which would also mean a higher rate of return on our investments. Gambling : Gambling is a very short term investment in a game. . which are explained below. Earning income is secondary. Given below are the basic rules followed by the fundamental investor.Investment vs. Results are determined by the roll of dice or turn of a card. Employs artificial risks while investment involves commercial risk. Entertainment is primary. Financial analysis does not reduce the risk proportion involved in gambling Approaches to Investment Decision Making As investors we would have diverse investment strategies with the primary aim to achieve superior performance. Time horizon is shortest. More specifically. it is suggested that it would be more profitable to analyze investor behaviour as the market is swept by optimism and pessimism. the current market price would reflect its intrinsic value at all times. which are different from their intrinsic values. Thus. Which seem to alternate one after the other. the academics have studied many aspects of the securities market and have developed advanced methods of analysis. . towards developing trading rules to make profits. point and figure charts. many securities have current market prices. sometime in the future the current market price would become the same as its intrinsic value. As psychic values seem to be more important than intrinsic values. When 'greed' has the lead stock prices tend to achieve dizzy heights. In the capital market. there is a positive relationship between risk and return. More specifically. In technical analysis the basic premise is that price movement of stocks have certain persistent and recurring patterns. which in turn is dependent on the underlying economic factors. Technical analysts use many tools like bar charts. the expected return from a security is linearly related to its systematic risk. So. with a view to study the internal market data. Stock prices behave in a random fashion and successive price changes are independent of each other.There is an intrinsic value of a security. moving average analysis. Psychological approach: The psychological investor would base his investment decision on the premise that stock prices are guided by emotions and not reason. Stock price behaviour corresponds to a random walk. Superior returns can be earned by buying under-valued securities (securities whose intrinsic value exceeds the market price) and selling over-valued securities (securities whose intrinsic value is less than the market price). This intrinsic value can be ascertained by an in-depth analysis of the fundamental or economic factors related to an economy. The basic rules are: The stock markets are efficient and react rationally and fast to the information flow over time. In this approach the investor uses some tools of technical analysis. there is a positive relationship between risk and return. This approach is also called 'Castle-in-the-air' theory. Academic approach: Over the years. the expected return from a security is linearly related to its systematic risk. This mood would swing and oscillate between the two extremes of 'greed' and 'fear'. industry and company. And when 'fear' takes over stock prices get depressed to lower than lower levels. market breadth analysis amongst others. However. past price behaviour cannot be used to predict future price behaviour. As a result. present price behavior can not predict future price behavior. This would mean "Current market price = Intrinsic value". This means that successive price changes are independent. In the capital market. This would imply that the stock prices are influenced by the prevalent mood of the investors. which can be derived from market trading data. We as fundamental investors can achieve superior results by buying undervalued securities and selling overvalued securities. At any point in time. and worth disposing of. Do technical analysis to assess the state of the market psychology. despite many instances of mispriced securities. However. nor as speculative as the psychological approach indicates. · Technical analysis is useful in broadly gauging the prevailing mood of investors and the relative strengths of supply and demand forces. While it is characterised by some inefficiencies and imperfections. it seems to react reasonably efficiently and rationally to the flow of information. since there are uncertainties associated with fundamental analysis. complicated technical systems should ordinarily be regarded as suspect because they often represent figments of imagination rather than tools of proven usefulness. More important. Respect market prices and do not show excessive zeal in ‘beating the market’. The basic premises of the eclectic approach are as follows: · Fundamental analysis is helpful in establishing basic standards and benchmarks. . worth holding. Equally important. · The market is neither as well ordered as the academic approach suggests. Combine fundamental and technical analyses to determine which securities are worth buying. However.Eclectic Approach The eclectic approach draws on all the three different approaches discussed above. exclusive reliance on fundamental analysis should be avoided. Accept the fact that the search for a higher level of return often necessitates the assumption of a higher level of risk. there appears to be a fairly strong correlation between risk and return. since the mood of investors can vary unpredictably excessive reliance on technical indicators can be hazardous. excessive refinement and complexity in fundamental analysis must be viewed with caution. Likewise.
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