Functions Investment policies - Institutional financing in India, Indian Financial system Video Lecture | Indian Financial System - B Com

one of the most important issues in
investing is the concept of an
investment policy or an investment
policy statement
unfortunately most investment textbooks
tend to ignore the investment policy
statement the ones that do include
investment policy statements tend to be
written by Chartered Financial Analysts
why because the CFA Institute places
great importance on constructing
investment policy statements if you ever
take the the CFA program you'll find in
the level three exam you'll write a
great many investment policy statements
and the reason investment policy is so
important is that before we can
determine what are the appropriate
investments for an individual we need to
know something about the individual some
of the things that they can help us to
determine an appropriate investment
strategy are things like time horizon
risk tolerance the individual's tax
situation their income needs their
return objectives what the investment
policy statement does is it serves
several purposes first it serves as a
sort of roadmap for the investor okay
where are we today and where would we
like to wind up if you don't have a plan
if you don't have a map it's hard to get
to where you'd like to be in some ways
you'll find that the investment policy
statement is a little bit like a
doctor's preliminary questions before
she starts the examination if you've
ever gone to a new doctor they always
ask you a lot of a lot of questions
about your family history is there a
family history of heart disease is there
a family history of cancer that helps
them to determine what tests they should
give you that helps them to determine
what specific things they should be
looking for okay
there's certain tests that you might
give to somebody
they're 50 years old but if there's a
family history of this type of disease
you might take the test when you're 30
or 40 years old okay
it helps them to determine what's the
appropriate course of action they may
ask you if you smoke
if you drink okay a lot of information
that can help them to to prescribe the
right course of action and finally the
investment policy statement is a
contract it's a contract between the
investment advisor and the client you've
sat down you've determined what the
goals are so that you know from the
investment advisors point of view it
provides some protection if the client
comes back and says well my investment
advisor took too much risk we can go to
the investment policy statement we can
see that the client has signed off on it
and said I'm willing to accept these
risks because I'm 30 years old I'm young
and I'm willing to take those risks for
the client again it serves as a way to
judge what the investment advisor has
done if you go in and you've said I want
to take moderate or low amounts of risk
and your investment advisors put you in
high risk securities again you have a
contract that says that you know the
investments that your advisor came up
with
we're inappropriate all right so the way
the cfa institute does it is that they
look at return objectives risk tolerance
time horizon taxes liquidity and any
legal considerations you'll find that
other investment policy statements cover
most of these slightly differently
perhaps and you can actually search out
on the Internet investment policy
statements and you'll find them for
charitable organizations if you're
thinking of donating to a charity you
might want to know what is their
investment policy you know what kind of
risks are they taking how are they using
the money so this can be valuable for
for a lot of people not just the people
involved in
investing so let's take a little more
specific look at some of these factors
okay return objectives you want to be
specific return objectives like I want
to make as much money as possible aren't
very helpful for the investment advisor
in fact they may be detrimental because
that person may wind up choosing
high-risk securities for the individual
just because that person wants to get
the best return when they don't really
or shouldn't be taking that much risk so
things like I'd like to have a hundred
thousand dollars a year in retirement
with that amount growing at the rate of
inflation is a much better return
objective because it's much easier for
the investment advisor to prepare a plan
that can generate that income and that
growth in the to keep up with inflation
risk tolerance nobody likes risk okay
most of us are risk averse but what
factors determine how much risk we can
tolerate well part of it's a
psychological makeup some people just
don't like risk if they if they find out
that their portfolio lost ten dollars
they can't sleep at night okay those are
people who need to have very safe
securities a very safe portfolio but
factors such as your age if you're very
young you have some time to catch up if
the markets gone down okay what's your
income if you have a good solid income
then you don't need to live off of your
investment portfolio then you can afford
to take more risk if you have a great
amount of wealth you can take more risk
okay
what are your liquidity needs that is
how soon do you need to get your money
and also time horizon those pop up also
on the investment policy statement so
we'll just we'll discuss those next okay
time horizon when do you need your money
if you need your money tomorrow you have
to take a very conservative investment
approach
if you have a longer horizon you can be
more aggressive you can invest in longer
term assets such as stocks okay a person
may have a number of time horizons okay
some short-term goals for things such as
buying a car okay or an intermediate
goal of financing your child's education
and then a longer-term goal such as
financing retirement so you may have a
number of time horizons and how we
invest the poor the proceeds for each
one of those accounts will depend on the
time horizon for each one okay taxes
taxes are an important part of
determining suitable investments someone
who's a wealthy individual who's in a
high tax bracket may benefit from tax
tax-free bonds they may benefit from
buying stocks that pay very little
dividends but a lot of capital gains
because if you don't sell the stock you
don't have to pay the tax okay liquidity
when do you need your money if you need
it soon you need liquid assets that is
assets that can be easily converted to
cash at a fair price something like a
Treasury bill or a money market account
or a bank savings account tend to be
very liquid you can go into the bank get
your money out no problem okay no loss
but if you happen to have a house a
house is not a very liquid asset if you
want to sell your house tomorrow you may
have to sell it at a at a loss so that's
not a very liquid asset so that's a
that's an issue too if you don't have
any great liquidity needs because you
have a good income and you don't have a
great many expenses then you can be more
aggressive with your investing and legal
considerations there are a number of
legal considerations that you have to
think about as an investor as an
individual obviously you need to obey
the law you need
to avoid things like insider trading but
you also need to know things like how
much can I contribute to my retirement
account what's the maximum you also need
to know how much I need to withdraw from
my retirement account if I happen to be
age 70 and a half because if I don't
take out enough there's a penalty so
let's take a quick look and a couple of
examples here I'm sorry what's one more
thing here for the legal considerations
if you happen to have a charity or a
foundation there may be a legal Charter
that has to be followed for an
individual you just need to obey the law
but for a a charity they may have a
charter that specifies how the money is
spent what portion can be spent and you
have to follow that when setting up the
investment the investment portfolio okay
let's take a look at a couple of
different cases here okay
the rich family doctor and mrs. rich
both 35 years old they have a combined
income of a half a million dollars
they're professionals they don't have
any children they're not planning to
have children they're in the forty
percent tax bracket and so they're in a
high tax bracket mrs. rich has just
inherited a million dollars the two of
them don't expect to use the principle
or the income from the this account
until they reach until they retired age
65 and any money that's left over after
their death goes to a place called Life
Ministries and let's look at Life
Ministries here we have a tax exempt
charitable organization and it has a
charter and the Charter requires an all
income earned from the endowment must be
used in operations any increase in the
value of the principle of the endowment
must whether it's realized or not that
is whether the stocks are sold or not
must remain in the endowment so they
have they need a hundred and twenty five
thousand dollars a year in income to
fund their operations and they happen to
have a two
a half-million dollar endowment
portfolio so let's take a look at their
circumstances now I've sort of
abbreviated things here you should be
more specific when you create an
investment policy statement but the flip
family what's the return objective they
can talk they can seek high returns why
because they can tolerate a lot of risk
if you want higher returns you have to
take more risk they have a very good
income they're not expecting to need any
of the money that mrs. Foote has
inherited their risk tolerance is high
again they have a good income we don't
have a lot of information about them but
you get the feeling that they don't have
any great liquidity needs so because of
their because of their large income so
they can take a lot of risk okay they
can invest in a lot of stocks perhaps
some growth stocks which will likely
have a better return over the longer run
they have a long time Verizon at age 35
they're not retiring for 30 years which
is a long time and they may live another
25 or 30 years after they retire so they
may have another 60 years of investing
so that's a very long time horizon
oftentimes people make the mistake of
thinking that I'll be retiring in ten
years I have a short-term modest time
horizon when you'll be retiring at 55
you may live 40 more years you may have
a 50 year time horizon taxes are
important we need to take that into
consideration because they're a very
high tax bracket because they have such
a good income it seems that they have
small liquidity needs if their car
breaks down they should be able to get
it repaired or replaced with that half a
million dollar income and any legal
considerations they just need to obey
the law okay you know how much they can
put in you know they don't want to get
penalized for putting too much into
their retirement account obviously they
don't want to engage in insider trading
etc in the case of Life Ministries
what's their return objective this is a
lot more specific they need to generate
a hundred and twenty five thousand
dollars in
income every year and we want it to
appreciate enough to offset the rate of
inflation their risk tolerance is
moderate because they have a long time
horizon ok charities can stick around
for many many years
ok the Red Cross the United Way many of
these charities have been around for for
you know decades ok sometimes you know a
hundred years or more so they have a
long time horizon they're tax exempt so
things like tax exempt bonds are not
appropriate for them liquidity it
doesn't seem to be a major factor they
just need to generate this hundred and
twenty five thousand dollars and legal
considerations they need to follow the
Charter requirements that say that they
can they have to spend any income they
generate so any interest or dividends
they receive they have to spend but any
growth that they get that is any
increase in the value of the principal
that is if the stock's price goes up
whether they sell the stock or not that
has to stay in the endowment so you can
see that both of these circumstances
okay or both of these portfolios the one
for Life Ministries and the one for the
rich family are going to be different
their investment policies are going to
be different and their investments are
going to be different so it's important
that you understand that before you
construct their portfolios