Similarly, there are a vast number of investment hypochondriacs who suspect their asset portfolios to be suffering from some dangerous disease. Generally, they believe that this disease can only be diagnosed by having a specialist examine the portfolio and test it by applying exotic formulae that will perform some magical analysis. Somewhat like its medical version, investment hypochondria, too, is encouraged by these specialists who claim to detect and cure exotic diseases suffered by investment portfolios.

One of the most popular type of diseases in this field is a faulty asset allocation. Many people are worried sick about whether their investment portfolios have the correct amount of money allocated to debt and equity. Periodically, I get asked about what the formula for calculating asset allocation is and sometimes I’m actually asked this not by a patient but by a budding specialist.

The problem, of course, is that there is no formula, nor can there ever be. Asset allocation is just a fancy term for investing according to your needs.

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Try to get anyone like this to plan your investments and they’ll start by putting up a charade whose purpose is to convince you that finding out correct asset allocation is a complex process that requires proprietary formula being churned up in complex looking spreadsheets.

By this process, deciding on an asset allocation starts by figuring out how risk-averse you are and how much risk you are willing to take to get the returns you want. This sounds so logical and systematic but is actually completely useless. Professional investors who are investing other people’s money may be able to find out their location on a risk-vs-return continuum, but at the back of their mind, everyone else wants zero risk. And guess what, zero risk is effectively possible if you do asset allocation the right way.

The key to really figuring out asset allocation is simply to make a rough time table of the future, one where you try and lay down when you will need how much money. Now, what you need to understand is that over some time horizon, most asset types turn zero risk, or as least as close to it as humanly possible. What you need to do is to match your investment time horizon (and not some theoretical risk level) to the asset type.

Assets like bank Term Deposits and cash mutual funds are always zero risk, short-term income funds are zero risk after six months, and a good stock portfolio like a well-chosen set of diversified equity funds are close to zero risk after maybe seven years.

I’ll admit this is a slightly simplified view but what I’m trying to do here is to demonstrate the principal on which individuals should base their asset allocation. There is no formula for asset allocation. The right way to do this is to figure out what you plan to do with your money in the future. Risk and reward. They are two sides of the same coin – at least that’s the way it’s supposed to work for stock investors. If you assume the risk of investing in a stock, you should expect a reward that is appropriate to the risk.

Estimates of the total value of assets managed according to Shari’a-compliant principles range as high as $750 billion, in other words Islamic finance is now a worldwide phenomenon.

The Islamic funds market has developed at a slower pace, but its potential is clearly huge. There are now more than 400 Islamic funds – four times the number at the turn of the century.

On the whole, the performance of Equity funds has been positive. Studies have shown that excluding financials, defense, tobacco, alcohol, leisure and entertainment stocks – as these funds must do if they are to remain Shari’a compliant – is no big disadvantage. The range of asset classes has mushroomed; a few hedge funds have also been launched.

The pace of product innovation has picked up in recent years; there are now a number of multi manager products on the market. Unit linked savings and retirement plans began to emerge few years ago, but the market is expanding fast and as many as 39 Banks have applied to distribute insurance in Saudi Arabia alone.

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The growth in this market has attracted many of the leading names. The likes of AXA, Allianz, AIG, Aviva to name a few have are already offering financial products in a number of markets.

As in any upcoming venture there are hurdles to overcome. One is lack of uniform regulation and there are no rules for certifying financial planners and investment advisers in the region.

In a study produced earlier this year by the Islamic Research and Training Institute, the Islamic Development Bank and the Islamic Financial Services Board has predicted that more than half of all financial services delivered within the Gulf Cooperation Council will be Shari’a compliant by the year 2015. Given estimates that suggest Islamic finance products are currently reaching only 10% of their potential target market, a considerable expansion looks justified.

Shari’a compliant funds have the potential to appeal to a wider constituency of investors keen to pursue socially responsible investment (SRI) principles. The Shari’s market may still be small but it offers big potential over time.

Now you will just not have any idea of how apt that statement is unless you’ve actually read Cosmopolitan (really read it, not just look at the pictures) but I like to believe that fund investors who read Mutual Fund Insight are very different from those who don’t. I have believed so far that there are two kinds of fund investors-thinking ones and non-thinking ones. And those who invest their time and money in reading this magazine must be the thinking ones.

What distinguishes the two? The non-thinking ones are the ones who just follow whatever seems to be the flavor of the day. The thinking ones are those who carefully weigh their options, consider the facts and then take rational decisions. However, in recent months I have seen that sometimes, the final step is the same.

The non-thinking ones unthinkingly follow the flavor of the day. The thinking ones think carefully, then just ignore the conclusions and follow the flavor of the day. They look at returns, ratings, portfolio statistics and whatnot, but then turn around and invest purely driven by the fear of getting left behind by everyone else.

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Non-thinking and non-knowledgeable investors have many reasons for investing. These are normally the ‘it’s available at par’ category of reasons that even a mildly knowledgeable investor should just laugh at. But the funny thing is that knowledgeable investors are investing not for laughable reasons but for no reason at all.

I’d like to tell these people, forget about learning more about investing you probably know enough already. What you don’t know is about your own psychology as an investor. The fear of not doing what everyone else is doing coupled with high pressure marketing appears to have overcome their rational thought. What is worse is that like all irrationality, this too seems to get drastically magnified by high stock prices.

All of which appears to be building up to a situation where investors will put in a lot of new money into mutual funds with expectations that are so high that they cannot be met.

The die is, well and truly, cast.

This really struck a chord in mind, more so because, as it happens, I have with me a great deal of first-hand information about the performance of Portfolio Management Schemes. Over the last few months a lot of people have gotten in touch with me complaining about how they’re making less money in these schemes than they would have made had they invested even in average equity funds.

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Looking at the details of these people’s returns from (PMS) is a revelation. In many cases, the raw returns are what an average or at most a second quartile diversified equity fund would have given them. But once one deducts the amazing fees that PMS’s charge, and deducts the tax hit that is delivered by many of these schemes’ completely tax-oblivious way of booking profits, what is actually left for the investor is a pathetic apology compared to what they could have gained by investing in almost any equity fund with a good long-term track record.

The sad part of the story is that some of these PMS’s are operated by the very same outfits whose own fund companies delivered much superior returns. But of course, fund companies’ profits are a pittance compared to what PMS’s earn.

Why are more and more people falling for this racket? Obviously, because of hard-selling of the ‘exclusivity’ that these schemes provide, coupled with the complete lack of transparency about PMS returns. Mutual funds have to make claims that are backed with public revelation of data but PMS salesmen can get by with just whispering an unapprovable claim in your ear.

Here’s a piece of advice for PMS customers. Since you are a PMS customer, you are obviously rich. Just as obviously, you didn’t get rich because you are stupid about money. At a guess, you are probably much smarter about money than the average guy, which is why you are rich.

I’m sure you like buying and using nice things–products and services that are a privilege of wealth. That’s the whole point of being rich–it’s what makes it more fun to be rich than it is to be unrich. However, do yourself a favor–spend your money on things that the unrich can’t buy instead of wasting it by paying more than the unrich do for the same stuff. Buy a beach villa (or on the French Riviera) instead of co-op flat, buy a limousine instead of that small car, commute in a helicopter instead of a limousine, bribe a minister instead of a clerk, keep an expensive mistress instead of a well, whatever. But DO NOT pay more to a PMS and end up with less return than the unrich get in a plain old mutual fund.

Something similar has been happening for stock investors as well. Even though there were some stocks that lost money, an overwhelming number of them went up by huge margins. There isn’t really any stock or mutual fund investor out there who didn’t make a great deal of money. Therefore, what we have here is like an examination which everyone clears because the passing marks have been reduced to zero.

These are abnormal times which are very dangerous precisely because it’s impossible to make mistakes. You can invest in bad companies and bad funds and still make money. And that means that when the going gets even slightly tougher, a lot of people will find that they actually did invest in bad companies and in bad funds.

It’s an old saying that more investment mistakes are made in good times than in bad times and since the times are so good right now, the potential for making mistakes is that much higher. Investment markets change direction very quickly. Nothing prevents what look like good investments today from turning out to be bad ones.

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A large part of the money that is being invested by individual small and medium investors is in response to an active sales effort by mutual funds, portfolio managers and insurance companies. Investors are not going out, doing their own knowledge gathering and then choosing. Rather, there is a high pressure sales effort which is finding easy converts because the rise of the stock markets.

Unfortunately, this is leading to most investment going into those investments which bring the maximum profit to the salesman, rather than to the one most suitable for the customer. In mutual funds, almost all new money is going into new funds which do not have a track record rather than to tried and tested ones. The reason is that fund companies are allowed to take out five per cent of the money collected as marketing expenses. Since this can’t be done with older funds, companies find it profitable to continuously launch new funds that are just minor variations of ones. The salesman who sells you mutual funds could possibly be making five times the normal amount for selling a new fund. No wonder his ‘advice’ is always for buying new funds.

Paradoxically, these are great times for investors but they are also the times that demand the greatest caution. The hype is so loud and so convincing that it takes a very cool and balanced head to make the right decisions.

It’s good to be confident, or so all of us were told when we were young. Confidence will make whatever you want achievable. So it must be very good that I’ve been meeting a lot of very confident investors these days. I met a man who started investing in stocks only three months ago and whose investments have returned more than 25 per cent during this period. That’s an annualized return of more than a 100 per cent a year, as he proudly-and accurately-informed me. Someone else I ran into started investing in February 2004 and have more than doubled his money. He has made a very confident projection that showed how fabulously rich he was likely to be in about five years’ time.

Of course, this is not just amateur hour-professional investors too are sounding like the gentlemen above. I met the marketing chief of a mutual fund company who had many megabytes of marvelously entertaining PowerPoint slides about how his fund managers had generated great returns over the last three years. I did ask him about what their returns had been like before that but the response I got made me feel that I had said something very rude.

Welcome to the land of investing geniuses, no one in this world has made any mistake on the stock market for as long as they can remember.

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This is dangerous territory. It is a fact that investment decisions made during bull-runs result in eventual disaster far more than those made when the markets are down in the dumps. This is basic psychology. Most human beings are inherently optimistic. When the markets are rising, almost every one of us likes to believe that we are making money because of our savvy decision-making.

As long as the going is good-and the going can sometimes stay good for years-almost any investment does make money. However, by the time the stage comes when millions of occasional investors are being pulled into the markets like moths to a flame, all the safe money has already been made. There was a time when there were great stocks available at value prices, but that is no longer true. There is probably still money to be made in the current cycle of the stock markets but getting this money from someone else’s bank account into your own will involve buying high and selling even higher later.

Buying low to sell higher, which allows you the luxury of buying low to sell low if things go wrong are no longer possible. As the well-known theory states, you now need to buy like a fool and hope for a bigger fool to come along later.

Does this mean that you shouldn’t invest anymore? No it doesn’t. What it does mean is that most of the stocks that the newly minted geniuses are buying are those that are being talked up by smart operators who have found bigger fools.

This is a time for caution. A time when any good investor is as mindful of his own psychological responses to the sight of others making money as he is of the moves of the market.

There’s no magic involved in reaching the million-dollar mark. If you set goals, do the research and start investing now, you can hit your wealth-building target on schedule. And you don’t have to be a financial whiz! What are needed are time, sacrifice and consistency.

Time is most significant: The longer you invest, the smaller the amount you need to put away each month to reach $1,000,000. Thus the younger you are when you start investing; the younger you’ll be when you join the million-dollar club. Many of the estimated 8 million millionaires began investing in their teens, and always with a long-term goal. Let’s say you’re 28 years old now, with no money saved or invested and would like to have a million-dollar portfolio of investments by the time you turn 60. You will need to invest $300 a month in stocks or stock mutual funds that have at least an 11 percent annual rate of return. If you increase your monthly investment to $500, you’ll hit your mark by age 54.

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Failure to sacrifice stands between most of us and that million-dollar nest egg. Investing means forgoing present consumption to build future wealth. Buying shares in mutual funds lets you own a wide variety of stocks, thus spreading the risk. And professional portfolio management relieves you of having to decide which stocks to buy and if and when to sell. But if you choose to invest independent of a financial adviser or broker, read the mutual funds’ prospectus to be sure they match your goals.

Consistency will help you reach your goal on target. By investing regularly, you’ll become disciplined, spend less and put more money to work. Let’s say you buy shares in a stock mutual fund using a dollar-cost averaging. Your money will buy more shares when the price is low and fewer when it’s high, but your average cost per share will be lower than if you buy a constant number of shares regularly.

Once your portfolio reaches the magic million-dollar mark, whatever else you do, don’t stop investing; given the inflation rate–even a relatively modest rate of 3 percent a year–in 22 years $1,000,000 will have the buying power of $521,892 in today’s dollars.

Your chances are increased that if one area falls another area that you have invested in will remain strong, and your assets will be protected..

I define risk as the probability of things going wrong. Once things have gone wrong, they cannot go right. Older investors will remember this feeling they have after their losses, of wanting to turn the clock back. It is the same feeling you get after losing a loved one, when you want to reach out and touch the person after she or he is gone.

The preventive part is all about ‘diversification’, almost the only way to manage risk as defined in financial markets. Both risk measurement and diversification lend themselves to mathematical and statistical analysis, giving classical finance its biases. .

Value investors do the opposite. They add to their positions as a scrip goes down, playing to be the ‘last man standing’, i.e. trying to buy the last falling share as sellers depart the stock. The more of these ‘last’ shares they can pick up, the better their returns, provided of course, they have bought a safe, steady business at a great price, and the business recovers subsequently. .

In this strategy, you should try to trade a correlated pair as part of your diversification strategy. Like buying the market leader and short- selling the market laggard. A caution here is that if you are buying at the bottom of the cycle, then the laggards gain more than the market leaders. In a bull market, buying the market leader and short-selling the laggard may be a good trading strategy. Make sure that you don’t make a mistake in reading the market for example, is this a bull market or a bear?. Across the world, the cost of capital will soon start to drop. That would suggest a very shallow bear market, if we see one at all. Even a normally ‘bearish’ person like me is not willing to take a stand.

Statistically one thing is clear – traditional means of diversification won’t save you. Remember one common mistake: mindlessly diversifying into, say, 100-200 stocks, which then go unmonitored for entry and exit points. Since the investor no longer knows enough about these businesses, he is prone to fall prey to rumors. In effect, the act of ‘diversifying’ will actually increase the probability of losses rather than reduce it.

True diversification includes far more investment choices than just stocks and bonds. It includes other non-correlating asset classes that don’t intrinsically involve either speculation or timing. Aggressive investors like the readers of this article must be having more than 50 per cent of their net worth in equities, especially if they are below 40.

With each investment be sure to invest no more than you can afford to lose, so you can sleep at night. And use dollar cost averaging – taking a fixed proportion of your personal savings each month to add to your investment holdings, so that volatility becomes an advantage over a long time horizon. Only then will diversification begin to make statistical sense.

What, you may ask, is the connection between minimalism and investments? A very close connection, I think. When I look at the market for investment products today, and see the kind of investment portfolios that people are collecting, I think there’s a strong need for a self-conscious and aggressive minimalism in investment planning. What is happening now is the very opposite. The loudest messages about investments and savings that reach people are advertising about the launch of new mutual funds. This collective impact of these messages is to fabricate the idea that your investment needs are best met by portioning out little bits of your savings into a large number of exotic and specialized mutual funds.

Here’s a sampling of just the last few months. There are funds specializing in different sizes of companies-large, medium, small and micro. There’s a fund for companies that are facing ‘unique’ situations, which are apparently different from ’special’ situations. There’s a fund for investing in companies that will benefit from increased infrastructure spending and one for only companies that will benefit from increased consumer spending. There’s a fund for investing in companies that are growing fast and another one only for companies that will grow fast in the long-term. There are even some funds that specialize in companies of all sizes although that’s clearly a meaning of the word ’specialize’ that’s not there in any dictionary that I have seen.

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If you add up the collective impact of this marketing message, you end up with an investor who is desperately trying to figure out a portfolio that will perhaps consist of three to five per cent each of maybe thirty funds. That’s not an exaggeration. I’ve seen people whose portfolios contain more than a hundred funds, most of them less than a per cent each. Basically, people end up buying into each new fund’s pitch from a salesman and invest a few thousand rupees every time a new fund comes out. The very idea of a mutual fund makes sense only so that the individual investor does not have to figure out which companies to invest in. If the problem of choosing companies is to be replaced by that of figuring out whether a given bit of money should go into this exotic idea or that one, then nothing much has been achieved. This kind of investing doesn’t help anyone except the salesman and the fund company.

A portfolio of even twenty funds, each based on a different idea, is impossible to track and organize and in any case has no connection with what is needed to meet your own investment goals. But there’s isn’t any grand solution to this problem. This is the way it’s going to be. Fund companies are going to keep up a stream of new funds which are differentiated from earlier ones by ever more meaningless features. And perhaps a majority of investors are going to fall for each new story. If you would like to be part of the minority of sensible investors, then you should stick to a minimalist approach. Choose few mutual funds with a good long track record and stick to them, leaving all other thinking to the fund’s investment manager.

Trust me; you don’t want to spend your time worrying about whether funds which invest in amazing companies are a better investment than those that invest only in unusual companies or the other way around.

They’re boring and passive. They are run on autopilot by hands off managers.

A portfolio manager actively manages the traditional equity fund. They buy and sell stock frequently in attempts to “outperform the market,” usually defined by a broad measure.. Index funds are passively managed. Their manager’s buy and hold only the stocks contained in their chosen benchmark. Their aim is to imitate returns, whether the market goes up or down.

They sell only when an investor redeems his investment or if a stock is kicked out of the Index. This passive investment saves money on research, salaries, and other overhead, and it avoids the emotional traps of buying at the top and selling at the bottom that torment active managers. The biggest saving for Index funds is the brokerage and other trading costs which active manager incur on their hyper active trading. In theory, this all leads to higher returns.

Which of the two is better? Let’s look at the odds. But with their growing numbers, it is difficult to guess how many will beat the benchmark in the long-term. And as the number of fund increase, it will get tough to pick the winners. And you will have to work to pick the right ones. But it takes little effort to pick an index fund that delivers almost the same return. You certainly won’t beat “the market,” but you’ll beat almost everyone working hard to make a choice.

Besides, index funds give you the diversity with discipline. You don’t run the risk of building large position in a small, illiquid company that concentrates you in one industry. Index funds give you a healthy dose of large companies that represent many industries, and the shares of these funds are easily bought and sold.

Which index fund should you pick? Every thing being equal the least expensive fund will be a winner. And recurring fund expense is a function of a funds size. The larger the fund, lower the expenses.

Besides, as an Index fund investor, you’re not getting any extra value. After all, the fund is merely trying to match the index. As you don’t need an advice to buy an Index fund, so you should never pay a sales charge on an index fund. But every Index fund (barring the tax saver) available today charges a load as they pay the fund sales man to sell the concept.