Investing Assets Allocation and Diversification Investing Series I Education Hub The term “asset allocation” is often used to describe the money management strategy that designates how capital should be distributed within an investment portfolio.  Learning Tip Asset allocation typically involves identifying how much of the portfolio should be distributed into various asset classes, or broad types of investments such as stocks, bonds, commodities, and cash. Understanding Asset Allocation The objective of asset allocation is to optimize the mix of the investments into different asset classes in order to maximize the return of the investment portfolio while minimizing the potential risk, based on an investor’s timeframe, risk tolerance, and long-term investment goals.  Evidence exists that suggests certain asset classes perform better or worse depending on economic conditions, market forces, government policy, and political influence. The goal of an asset allocation strategy is to identify these conditions and allocate resources appropriately. Utilizing asset allocation strategies as a form of risk management is not a new concept. The idea of “not putting all of your eggs in one basket” is something we learn as children and has been around for thousands of years. Even before the advent of modern financial markets, people understood that one’s assets should be divided among different classes such as one’s land, the ownership of a business, and reserves (cash). This is called classical portfolio management or theory. So, now you have basic understanding of asset allocation. let’s look into Diversification. Understanding Diversification A concept that is closely associated with asset allocation is “diversification”, and in practice, these terms are often used interchangeably. Asset allocation, however, is principally concerned with allocating capital into different asset classes. For example, a typical asset allocation strategy might dictate that your portfolio should have 50% invested in stocks, 30% invested in bonds, 10% in commodities, and 10% in cash.  Diversification is typically associated with the allocation of capital within those asset classes. For example, within the stock allocation of the same portfolio, investments could be allocated to 50% large-cap stocks, 20% mid-cap stocks, 10% small-cap stocks, 10% international stocks, and 10% emerging market stocks.  The concept of diversification involves the distribution of assets within individual asset classes – while risk is distributed among the asset classes of the overall portfolio, diversification reduces risk within each asset class. Understanding Limitations of Asset Allocation Even with all of the benefits it provides, using asset allocation as a risk management strategy has limitations. Being aware of these limitations will help investors realize when other tools may be used to minimize risk in their portfolios. One major criticism of asset allocation is that “Black swan” events (unexpected events that have catastrophic consequences) seem to occur more often in the financial markets than would be statistically expected if the markets truly followed a normal distribution. If this is true, using standard deviation as a measure of risk may be misleading, and statistical correlation between asset classes may be distorted. Also, correlation tends to increase between asset classes during a crisis period, which would make asset allocation less useful as a risk management strategy precisely when it is needed most. Another criticism of asset allocation is that it does not tell the investor when to buy or sell a security. Buy and sell decisions are based on reallocating the portfolio (usually arbitrarily) when it appears to need rebalancing due to the investor’s risk parameters, without regard to changing market conditions. Tactical asset allocation strategies can be used to address some of the timing of buy and sell decisions, which are usually not part of strategic asset allocation investment decisions. Finally, asset allocation as a risk management tool does not address the risk of portfolio drawdown. Drawdown is defined as the minimum value of a single investment or investment portfolio reached following a previous peak in value. During secular bear markets, portfolio drawdown can be significant. Get PRO Get access to exclusive premium features and benefits. Subscribe a PRO plan. See More Related Topics Using Index for Investing Stages of Stock Market Load More

Investing Investing vs Speculating Investing Series I Education Hub In this article, we will see what is investing and how it differs from speculating. Investors and traders take on calculated risk as they attempt to profit from transactions they make in the markets. The level of risk undertaken in the transactions is the main difference between investing and speculating. Learning Tip The main difference between speculating and investing is the amount of risk involved. Investors try to take on an average or below-average amount of risk. While speculators are seeking to make abnormally high returns from bets that can go one way or the other. Understanding What is Investing? Investing means the buying and selling of securities such as stocks, bonds, exchange traded funds (ETFs), mutual funds etc. in long duration. Investors hope to generate income or profit through a satisfactory return on their capital by taking on an average or below-average amount of risk. Income can be in the form of the underlying asset appreciating in value, in periodic dividends or interest payments, or in the full return of their spent capital. Most often, investing is the act of buying and holding an asset for the long-term. To classify as a long-term holding, the investor must own the asset for at least one year. For duration less than 1 year it is called short-term investing. For example, consider a large-cap stable company as an example of investing. This company may pay a consistent dividend that increases annually, and it may have a low business risk. An investor may choose to invest in this company over the long-term to make a satisfactory return on their capital while taking on relatively low risk.  So, this is enough to understand what really investing is. Now let’s look into speculation. Understanding Speculation Speculation is the act of putting money into financial endeavors with a high probability of failure. Speculating seeks abnormally high returns from bets that can go one way or the other. These traders buy securities with the understanding that they will be held for only a short period before selling. They may frequently move into and out of a position. For example, consider a volatile new AI based tech company with an equal chance over the near-term of skyrocketing from a new AI revolution. Speculators may believe the AI company will become very large tech company in very short time and may buy its stock on a hunch. This hunch and the subsequent activity by investors are called speculation. Comparison Which One is Better? Both investors and speculators put their money into a variety of different investment vehicles including stocks and fixed-income options. Stocks or equities represent a certain percentage of ownership in a company. These are purchased on exchanges or through a private sale. Companies are ranked by market capitalization or the total market value of their outstanding shares. Investors may want to consider the holding period for their investments and their tax implications. The holding period determines how much tax is owed on the investment. This period is calculated from the day after the investment is purchased until the day it is sold or disposed of.  The Internal Revenue Service (IRS) considers holdings of one-year or more to be long-term. Anything below this is considered a short-term investment. Long-term gains are generally taxed more favorably than short-term ones. The primary difference between investing and speculating is the amount of risk undertaken. High-risk speculation is typically akin to gambling, whereas lower-risk investing uses a basis of fundamentals and analysis. Get PRO Get access to exclusive premium features and benefits. Subscribe a PRO plan. See More Related Topics Using Index for Investing Stages of Stock Market Load More

Investing Fundamental Analysis: Pros and Cons Investing Series I Education Hub In this article, we will see the strengths and weaknesses of the fundamental analysis. This will help you to know what fundamental analysis can do and what it can’t in a better way. Learning Tip Fundamental analysis is a greatly effective method for long term investing. It helps you to understand the true value of stock by understanding or valuing its business. But you should know everything about it. It means you must be aware of its strengths and weaknesses both. Understanding Strengths of Fundamental Analysis Long-term Trends: Fundamental analysis is good for long-term investments based on very long-term trends. The ability to identify and predict long-term economic, demographic, technological or consumer trends can benefit patient investors who pick the right industry groups or companies. Value Investing: Sound fundamental analysis will help identify companies that represent a good value. Some of the most legendary investors think long-term and value. Graham and Dodd, Warren Buffett and John Neff are seen as the champions of value investing. Fundamental analysis can help uncover companies with valuable assets, a strong balance sheet, stable earnings, and staying power. Business Acumen & leading indication: One of the most obvious, but less tangible, rewards of fundamental analysis is the development of a thorough understanding of the business. After such painstaking research and analysis, an investor will be familiar with the key revenue and profit drivers behind a company. Earnings and earnings expectations can be potent drivers of equity prices. Even some technicians will agree to that. Relative Valuation: Stocks move as a group. By understanding a company’s business, investors can better position themselves to categorize stocks within their relevant industry group. Knowing a company’s business and being able to place it in a group can make a huge difference in relative valuations. Now Let’s look into the weaknesses of fundamental analysis.  Understanding Weaknesses of Fundamental Analysis Time Constraints: Fundamental analysis may offer excellent insights, but it can be extraordinarily time-consuming. Time-consuming models often produce valuations that are contradictory to the current price prevailing on Wall Street.  Quite Specific: Valuation techniques vary depending on the industry group and specifics of each company. For this reason, a different technique and model is required for different industries and different companies. A subscription-based model may work great for an Internet Service Provider (ISP) but is not likely to be the best model to value an oil company.   Subjectivity: Fair value is based on assumptions. Any changes to growth or multiplier assumptions can greatly alter the ultimate valuation. Fundamental analysts are generally aware of this and use sensitivity analysis to present a base-case valuation, an average-case valuation, and a worst-case valuation. However, even on a worst-case valuation, most models are almost always bullish, the only question is how much so.   May based on lies: The majority of the information that goes into the analysis comes from the company itself. Companies employ investor relations managers specifically to handle the analyst community and release information. As Mark Twain said, “there are lies, damn lies, and statistics.” When it comes to massaging the data or spinning the announcement, CFOs and investor relations managers are professionals. Get PRO Get access to exclusive premium features and benefits. Subscribe a PRO plan. See More Related Topics Using Index for Investing Stages of Stock Market Load More

Investing Business Analysis Investing Series I Education Hub Once you have shortlisted stocks or companies, an investor might analyze the resources and capabilities within each company to identify those companies that are capable of creating and maintaining a competitive advantage. The analysis could focus on selecting companies with a sensible business plan, solid management, and sound financials. Learning Tip Finding a great stock for investment is more about finding a great business in investing. There are several key factors to study to find the right stock. Understanding Factors of Analysis Business plan: The Business plan, model or concept forms the bedrock upon which all else is built. If the plan, model or concepts stink, there is little hope for the business. For a new business, the questions may be these: Does its business make sense? Is it feasible? Is there a market? Can a profit be made? For an established business, the questions may be: Is the company’s direction clearly defined? Is the company a leader in the market? Can the company maintain leadership? these are most important factors to check the business plan. Company’s Management: In order to execute a business plan, a company requires top-quality management. Investors might look at management to assess their capabilities, strengths and weaknesses. Even the best-laid plans in the most dynamic industries can go to waste with bad management (AMD in semiconductors). Alternatively, even in a mature industry, strong management can make for increased success (Alcoa in aluminum). Financial Analysis: The final step to this analysis process would be to take apart the financial statements and come up with a means of valuation. Below is a list of potential inputs into a financial analysis. Like, Business Cycle, Business Idea, Business Model, Business Plan, Capital Expenses, Cash Flow, Cash on hand, Current Ratio and so on. There are enormous factors to assess. A complete financial model can be built to forecast future revenues, expenses and profits or an investor can rely on the forecast of other analysts and apply various multiples to arrive at a valuation. Some of the more popular ratios are found by dividing the stock price by a key value driver. Example, Ratio Company Type Price/Book Value Oil Price/Earnings Retail Price/Earnings/Growth Networking Price/Sales B2B Price/Subscribers ISP or Cable Company This methodology assumes that a company will sell at a specific multiple of its earnings, revenues or growth. An investor may rank companies based on these valuation ratios. Those at the high end may be considered overvalued, while those at the low end may constitute relatively good value.  Conclusion Important Points After all is said and done, an investor will be left with a handful of companies that stand out from the pack. Over the course of the analysis process, an understanding will develop of which companies stand out as potential leaders and innovators. In addition, other companies would be considered laggards and unpredictable. The final step of the fundamental analysis process is to synthesize all data, analysis, and understanding into actual picks. Get PRO Get access to exclusive premium features and benefits. Subscribe a PRO plan. See More Related Topics Using Index for Investing Stages of Stock Market Load More

Investing Fundamental Analysis Investing Series I Education Hub Fundamental analysis is the examination of the underlying forces that affect the well-being of the economy, industry groups, and companies. As with most analysis, the goal is to derive a forecast and profit from future price movements. Learning Tip Fundamental Analysis is one of the two methods of study of investing. A good understanding of fundamental analysis will help you to find undervalued and strong businesses and stocks. Understanding Uses of Fundamental Analysis At the company level, fundamental analysis may involve examination of financial data, management, business concept and competition. At the industry level, there might be an examination of supply and demand forces for the products offered. For the national economy, fundamental analysis might focus on economic data to assess the present and future growth of the economy. To forecast future stock prices, fundamental analysis combines economic, industry, and company analysis to derive a stock’s current fair value and forecast future value. If fair value is not equal to the current stock price, fundamental analysts believe that the stock is either overvalued or undervalued and the market price will ultimately gravitate towards fair value. Fundamentalists do not heed the advice of the random walkers and believe that markets are weak-form efficient. By believing that prices do not accurately reflect all available information, fundamental analysts look to capitalize on perceived price discrepancies. Steps to Apply How to Use Fundamental Analysis Economic Forecast: First and foremost, in a top-down approach would be an overall evaluation of the general economy. The economy is like the tide and the various industry groups and individual companies are like boats. When the economy expands, most industry groups and companies benefit and grow. When the economy declines, most sectors and companies usually suffer. Many economists link economic expansion and contraction to the level of interest rates. Interest rates are seen as a leading indicator for the stock market as well. Once a scenario for the overall economy has been developed, an investor can break down the economy into its various industry groups. Industry Group Selection: If the prognosis is for an expanding economy, then certain groups are likely to benefit more than others. An investor can narrow the field to those groups that are best suited to benefit from the current or future economic environment. If most companies are expected to benefit from an expansion, then risk in equities would be relatively low and an aggressive growth-oriented strategy might be advisable. A growth strategy might involve the purchase of technology, biotech, semiconductor and cyclical stocks. If the economy is forecast to contract, an investor may opt for a more conservative strategy and seek out stable income-oriented companies. A defensive strategy might involve the purchase of consumer staples, utilities, and energy-related stocks.  Finding Stocks within Industry: Once the industry group is chosen, an investor would need to narrow the list of companies before proceeding to a more detailed analysis. Investors are usually interested in finding the leaders and the innovators within a group. The first task is to identify the current business and competitive environment within a group as well as the future trends. How do the companies rank according to market share, product position, and competitive advantage? Who is the current leader and how will changes within the sector affect the current balance of power? What are the barriers to entry? Success depends on having an edge, be it marketing, technology, market share or innovation. A comparative analysis of the competition within a sector will help identify those companies with an edge, and those most likely to keep it. Get PRO Get access to exclusive premium features and benefits. Subscribe a PRO plan. See More Related Topics Using Index for Investing Stages of Stock Market Load More