Page 82 - DMGT515_PERSONAL_FINANCIAL_PLANNING

Unit 4: Measuring Investment Return

Banks, financial institutions, non-banking financial companies, housing finance companies and Notes
credit card companies use CIBIL’s services. Data sharing is based on the principle of reciprocity,
which means that only members who have submitted all their credit data, may access Credit
Information Reports from CIBIL.
With a view to strengthening the legal mechanism and facilitating credit information companies
to collect, process and share credit information on borrowers of banks/FIs, a draft Credit
Information Companies (Regulation) Bill was passed in May 2005 and notified in June 2005. The
Government and the Reserve Bank have framed rules and regulations for implementation of the
Act, with specific provisions for protecting individual borrower’s rights and obligations. The
rules and regulations were notified on December 14, 2006. In terms of the provisions of the Act,
after obtaining the certificate of registration from the Reserve Bank to commence/carry on
business of credit information companies will be able to collect all types of credit information
(positive as well as negative) from their member credit institutions and disseminate the same in
the form of credit reports to the specified users/individuals.
The risk management architecture of banks in India has strengthened and they are on the way to
becoming Basel II compliant, providing adequate comfort level for the introduction of credit
derivatives. Accordingly, the Reserve Bank, as part of the gradual process of financial sector
liberalisation in India, permitted banks and primary dealers to begin transacting in single-
entity credit default swaps (CDS) in its Annual Policy Statement for 2007-08 released on April 24,
2007.

Case Study The Reality of Investment Diversification

nvestment diversification, simply said, is “don’t put all your eggs in one basket.” This
is the traditional approach to investing that you’ll see promoted by many financial
Iadvisors and popular personal finance magazines and investment books.
Here’s the idea behind investment diversification. Suppose you invest $10,000 in five
different investments for twenty years. The results are below:
1. $2,000 in a high risk investment becomes worthless
2. $2,000 in a risk level four investment earns 10% and grows to $13,455

3. $2,000 in a risk level four earns 8% and grows to $9,322
4. $2,000in a risk level three earns 6% and grows to $6,414
5. $2,000 in a risk level one investment earns 2% and grows to $2,972
You invested $10,000 which grew to $32,163, which means, on average your investments
earned a 6% annualized return. Not bad.
Investment diversification is important. I advise you do it. I also advise you understand its
limitations.
The premise behind choosing to diversify your investments is that if you do it properly,
you will earn an average return of let’s say six to seven percent a year. Financial planners
will run a retirement plan projection for you using a rate of return based on this assumption.
They often neglect to account for a margin of error.

Contd...

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