Safety First

Any type of investment carries a risk. Level of risk depends on the type of investment your made. In this article I'm going to rush through the most common risks involved in various investments and what you can do to minimize the those risks.

I have parked my cash in Equities, Unit Trust, Bank FDs, Real Estate and a small amount in gold. Actually real estate was inherited from parents and I keep them as diversified asset. Also technically I haven't invested on gold. I just happened to have some jeweleries (precious metals and gems) without any emotional attachment. 

For a fact I know that equity return do beat everything else. Some times ago I was thinking about selling some of the real estate and invest that money on equity. But I held myself back because it balance my portfolio perfectly. As equity do generate the highest return, it is the most risky one from all options.
Roughly calculated, my distribution is as follows.
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1. Equity : 40%
2. Real Estate : 40%
3. Unit Trust : 10%
4. Cash(FD) : 10%
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A Word About Diversification

Diversification is a must have strategy, but a very relative term. What I mean by relative is you always need a reference frame to talk about diversification. For example, my asset allocation above is diversified in terms of different investment options. But 98% of it is based in Sri Lanka. Any macro economic shock will effect all of them. Therefore in a sense I'm not diversified at all.

Also I have heard some investors say that they have a very diversified portfolio of 30 companies. Apparently all of their wealth is invested on equities and managed by one person. Actually number of counters in a portfolio is not an indication of safety or diversification. I think for a self managed individual investor, about 12-15 counters is the max. A full time investors may be holding as high as 30-40 companies in their portfolio. But that should be backed by the time and resources available to them. As I don't have much time, 5-6 counters is ideal for me.

Equity Investment : Find a Healthy Company

You can put your eggs in lot of baskets to minimize the risk or you can put all your eggs in few baskets and monitor them well. As I said before I don't hold much counters in my portfolio. Therefore how healthy my holdings are a major concern to me. Following is what I mainly look at when assessing the safety of an investment.

1. ROE : Return on equity is a measure of how much company makes with the invested money. I always look for companies which make over 20%. i.e. When Rs.100/= is invested they make it grow to Rs.120/= at the end of financial year.
2. Five Year EPS and Dividend Growth Rate : It is very important to make sure the company is growing at a inflation beating rate. I usually look for a rate over 10%(preferably 15%).
3. Dividend Yield and 5 Year Average DY : Most of the time I ignore anything which yield less than 3%. 5Year average yield of 4% or higher is preferred by me.

  
Rule of 72 will become handy here. Rule of 72 calculate the number of years which will take for the yield to double. You simply divide 72 by the growth rate. i.e If you invest in a company which yield 3% and growing at a rate of 10%, your yield will become 6% in 7.2 years. 

Technically that is not a rule, that is mathematics. Actual calculation is ln(2) x Expected Growth Rate. ln(2) is approximately 0.69 . Number 72 is a rounded value of 69.31xx. 69 is more accurate, but 72 is widely used because 72 can be divided by most numbers and calculation is easy to done in mind. If you want to find the number of years which will take to triple the yield, just use ln(3) i.e 1.098x

Unit Trust : Get Professional Service

Unit trusts are managed by a professional team of fund managers approved by the Securities and Exchange Commission of Sri Lanka (SEC). Fund managers have resources and technical expertise far greater than individual investors. Therefore I think every investor should hold at least one unit trust in their portfolio. A direct advantage I get from unit trusts is, fund manager send a report of their top 10 holdings monthly. I have invested in NDB Growth Fund and Income Fund. This was their October status.

I keep monitoring the changes in their portfolio every month to get an idea of what's happening beyond my radar. This is the changes in growth fund which I have been tracking for a long time.

Counters marked RED are the ones which disappeared from top 10 list following month.
GREENs are the ones which appeared in the list during the reported month.
If you track back the changes and price movements, you will understand how smart the fund manager is.

Another advantage is, Unit Trusts give you the access to Government Bonds and Treasury Bills which are not available for individual investors. Also capital and dividend gains from unit trusts are totally tax free. There are other benefits such as Automatic re-investment plans, Minimum transaction cost etc. Unit Trust Association of Sri Lanka is a great place to learn more about unit trusts. Also you may want to check out NDB Auto Wealth Planner, which is a nice simulator you can use to create customized plans for you risk appetite.
 

Cash at Bank : Shock Proof Your Portfolio

Yes, this will really shock proof your portfolio. Unexpected emergencies such as family health, theft, accidents, natural disasters can drain your wealth very quickly. Selling my holdings in a bear market is my worst nightmare. I usually keep 1 Year worth of my salary as cash at bank. You can choose 4 Months, 6 Months or even 2 Years according to your level of risk. I have 4 grand parents, my wife(hoping to have baby next year) and a brother to look after. Therefore I maintain a 1Year buffer. It is advisable to keep at least 4 Months of family expenses at bank.

A great thing to do is, spread your emergency cash in to small blocks and open one FD per month. We hold 1x 1Month, 3x 3Months, 6x 6Months, 12x 12Months FDs. If you do this, you will find about 4 FDs are expiring and renewing in every month. In case of an emergency, you can choose which one is best to close considering the amount required and maturity level. If you think maintaining so much FDs a headache, I do that even without leaving my room. I don't know about other banks, but with Sampath bank it is just a mouse click.

You can select the period, renewal option, interest payable period(Monthly, Quarterly, etc) and which account to credit the interest(if you select no automatic renewal). It is so easy and my life would have been very different without Sampath Bank. Let me know if other banks offer this facility.
 

Other Assets : Beware of Non Revenue Generating Assets

I'm not a gold fan and I hate to hold assets which are not generating any revenue. Remember the house you live in and your car is not an investment. In fact they will drain your wealth as you need to maintain those. If you are holding a farm land, an apartment or a vehicle which can be rented, that will be a real investment. Be very serious when you are buying a non revenue generating asset. Think about the lifetime cost and your opportunity cost before going shopping.

This post is long, but it summarize the entire content of my blog. Let me know if you have anything to add or something you don't like in the content. I wish you merry X'mas, be Safe and enjoy the vacation!

Cheers...