For our example, let's look at a fictional investor named Tina. Tina is a twenty-something who is relatively new to investing, knows that she wants to invest, but isn't sure just how to do it. Her knowledge of finances is good, but she has no desire to spend her free time pouring over financial statements (or losing sleep because of her investments).
After checking out this tutorial, Tina learns that there are two basic styles of portfolio management: passive and active. Each of these styles embraces a different approach to investments. The goal of active management is to select securities that will perform better than the overall market. For example, when a mutual fund manager analyzes a company's financial statements to determine if the stock is suitable for the fund, he or she is actively managing the portfolio.
A passive investor on the other hand has no desire to try to research a stock or "beat the market" and relies on selecting the right advisor or mutual fund for his investments. Assuming that Tina's investment style is passive, so her investment vehicle of choice is a mutual fund. Let us assume that Tina invests in the HSBC Equity Fund. This is a mutual fund that predominantly invests in large and mid sized Indian companies. Effectively it means that Tina has invested in some of the large and mid sized companies in India without herself having to research each company or track its performance. Instead she has entrusted the fund manager to do the same and more.
Tina is still free to have a life and doesn't have to worry about picking stocks or bonds for that matter.
Tina gets instant diversification (because the fund owns many different kinds of stocks) without having to invest huge sums of money. Most mutual funds accept investments of as low as Rs. 5000/-.
Most importantly, the transaction fees (read brokerages) paid by mutual funds are far less than the cost Tina would have to pay for buying each stock separately in smaller quantities.
Tina doesn't just stop with her initial purchase. She uses a Systematic Investment Plan (SIP) with which she invests Rs. 2000/- of her paycheck every month in the HSBC Equity Fund. This allows her to take advantage of "Rupee Cost Averaging." By putting in a small amount every month (rather than a large amount once a year), Tina sometimes buys when the prices of the units of the fund are higher, and sometimes when prices are lower--in the end, the purchase prices average out. The best thing about rupee cost averaging, though, is that it gets Tina in the habit of saving every single month.
|Putting the Concepts to Work
Her money is definitely getting put to work, and she is becoming part owner of some of the biggest companies in India.
With no additional work, she can reinvest all the money that gets paid out through dividends, which allows her to see the benefits of compounding over time. The plan fits Tina's investing style (passive investing).
A strategy like this can be moulded to meet an investor's objectives and asset allocation. In Tina's case, she has a time horizon of 20-plus years, so she is comfortable being completely in equities. If an investor is not comfortable with being just in stocks, it's easy enough to buy a bond fund. It would still offer the low transaction costs, diversification, professional management and allow you to customize your asset allocation.