Page 59 - DMGT515_PERSONAL_FINANCIAL_PLANNING

Personal Financial Planning

Notes Step 3: Evaluating Specific Investments

The third step is evaluating specific investments that you are considering within an asset class.
There are tools you can use to evaluate the risk of a particular investment—a process that makes
a lot of sense to follow both before you make a new purchase and as part of a regular reassessment
of your portfolio. It’s important to remember that part of managing investment risk is not only
deciding what to buy and when to buy it, but also what to sell and when to sell it.
For stocks and bonds, the place to start is with information about the issuer, since the value of
the investment is directly linked to the strength of the company—or in the case of certain bonds,
the government or government agency—behind them.
Company Documents—Each public company in India must be registered under section 3(1)(iv)
of the Companies Act, 1956 and provide updated information on a periodic basis. The annual
report of the company contains audited financial statements as well as a wealth of detailed
information about the company, the people who run it, the risks of investing in the company,
and much more.

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Caution When you’re reading a company’s financial statements, don’t skip over the
footnotes. They often contain red flags that can alert you to pending lawsuits, regulatory
investigations, or other issues that could have a negative impact on the company’s bottom
line.
The company’s prospectus, especially the risk factors section, is another reliable tool to help you
evaluate the investment risk of a newly issued stock, an individual mutual fund or exchange-
traded fund, or a REIT (real estate investment trust). The investment company offering the
mutual fund, ETF, or REIT must update its prospectus every year, including an evaluation of the
level of risk you are taking by owning that particular investment. You’ll also want to look at
how the fund, ETF, or REIT has done in the past, especially if it has been around long enough to
have weathered a full economic cycle of market ups and downs—which might be as long as 10
years. Keep in mind, however, that past results cannot predict future performance. Also verify
that mutual fund managers have not changed. In actively managed funds, it is the managers’
picks that determine returns and the level of risk the fund assumes. Past returns would not
reflect a new manager’s performance.

Rating Service: It’s important to check what one or more of the independent rating services
has to say about specific corporate and municipal bonds that you may own or may be
considering. The ratings are provided by agencies such as Morningstar, Standard & Poor’s,
and Moody’s Corporation. All banks and financial institutions have their financial services
and products evaluated and rated by such companies, and many investors put their trust in
the ratings.‘ The higher the letter grade a rating company assigns, the lower the risk you
are taking. But remember that ratings aren’t perfect and can’t tell you whether or not your
investment will go up or down in value.

Notes Also remember that managing investment risk doesn’t mean avoiding risk
altogether. There might be times when you include a lower-rated bond or bond fund in
your portfolio to take advantage of the higher yield it can provide.
Research companies also rate or rank stocks and mutual funds based on specific sets of
criteria. Brokerage firms that sell investments similarly provide their assessments of the
probable performance of specific equity investments. Before you rely on ratings to select

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