Page 83 - DMGT515_PERSONAL_FINANCIAL_PLANNING

Personal Financial Planning

Notes
The impact of a margin of error is best explained with this excerpt from the book The Black
Swan:
“You would take a different set of clothes on your trip to some remote destination if I told
you that the temperature was expected to be seventy degrees Fahrenheit, with an expected
error rate of forty degrees than if I told you that my margin of error was only five
degrees.”

Diversification does help reduce investment risk, but you must remember that the long
term results of a diversified set of investments are far from certain.
Adding additional investment risk management techniques to diversification can improve
the odds that your investments will achieve the results you need them to achieve so you
can reach your financial goals.

Questions
1. What do you mean by investment diversification? Why is it advisable to diversify
your assets?

2. How can an investor diversify his assets?

4.7 Summary

The risk and return trade off says that the potential return rises with an increase in risk. It
is important for an investor to decide on a balance between the desire for the lowest
possible risk and highest possible return.
The important options available for investment are cash incentives, stocks, bonds, mutual
funds, derivatives, commodities, real estate.
Risk and expected return are the two key determinants of an investment decision. The rate
of return expected by the investor consists of the yield and capital appreciation.

There are three major determinants of the rate of return expected by the investor are:
(i) The time preference risk-free real rate
(ii) The expected rate of inflation
(iii) The risk associated with the investment, which is unique to the investment.

Two basic investment avenues are:
(i) Financial assets
(ii) Physical assets (real assets)
Non-security forms of investment include all those investments, which are not quoted in
any stock market and are not freely marketable, viz., bank deposits, corporate deposits,
post office deposits, national savings and other small savings certificates and schemes,
provident funds, and insurance policies.

Capital gain (or loss) is a profit (or loss) made while selling a capital asset.
If shares or equity MFs are held for less than 12 months before selling, the gain arising is
classified as Short Term Capital Gain. If shares or equity MFs are held for more than 12
months before selling, the gain arising is classified as Long Term Capital Gain.
If the capital asset is held for less than 36 months before selling, the gain arising from it is
classified as Short Term Capital Gain. If the capital asset is held for more than 36 months
before selling, the gain arising from the sale is classified as Long Term Capital Gain.

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