Do you remember reading about the periodic table of elements while in school? If you remember this fundamental bit from your school chemistry classes, then that will help you appreciate what I'm going to write and make you understanding your investment portfolio as well as the importance of choosing the right kind of investments. The periodic table of elements initially helped scientists make sense of the bewildering variety of elements that seem to occur in the world.
It helped scientists have a framework for elements, organising them in categories according to their physical and chemical properties. The existence of the framework was also evidence that there must be a deeper underlying mechanism that drives those properties, thus showing the path towards understanding the structure of the atom. The basic idea is that a system with a large number of types can become simpler to understand and analyse if you can break up each type into its constituents, analyse each of those constituents individually and thus understand how each type works.
This would help you understand each type. Most importantly, it would also give you a way of understanding any new type that you may come across without needing to bother about its externalities. You can break it up into its components and understand it better. It should be obvious by now that understanding financial products can work quite well on the same principles. In fact, this method seems tailor-made to understand financial products. So let's try and figure out a periodic table of financial products that are available to you as a consumer . There are only a handful of basic asset types, primarily equity, debt and perhaps commodities. There's also insurance cover that's available in the form of many products.
These elements have a few other properties that matter. Equity can be of companies of various sizes and sectors. Debt can be of various maturities and safety levels. There's also liquidity, or how quickly you can get your money back. Remarkably, our periodic table for understanding consumer financial products is almost complete , a good deal smaller than the 118 elements in the periodic table of elements. Let's put it through its paces by deconstructing a few common financial products . Consider a bank savings account : a 100% debt product, perfect liquidity, very high safety. Shift to a bank fixed deposit: 100% debt, very high safety but poorer liquidity. How about equity mutual funds? All equity, potentially high returns, poor safety , but high liquidity. This method of decomposing financial products is very useful in figuring out complex financial products that are composed of different types of financial elements . Consider a ULIP from an insurance company. It's designed to look distinctive from other ULIPs. However, it's composed of the same elements. It will have some equity, some debt and some insurance cover.
All of it will be packaged with some liquidity constraints. Compare that to a hybrid equity-debt fund from a mutual fund company. It also has some equity, some debt and might have some liquidity constraints if it's a closed-end fund. If you were to consider the elements alone, might it be possible that a balanced fund along with a term plan may be functionally identical to a ULIP while having better liquidity or cost characteristics? Similarly, the combination of an equity fund and a fixed deposit may deliver what you want better than a balanced fund that has the same mix. This is not to say that I'm recommending any of the above substitutions . I'm demonstrating that investors would do well to not look at the packaging of a financial product but the components inside. All financial products are composed of a remarkably small number of elements. Being able to readily figure out the elements and then see how they combine to form a compound is the only way to understand what you are being sold and what it is actually delivering to you.
By: Dhirendra Kumar, CEO Value Research
Source: Economic Times
Thanks and Regards,
Sanchari Sinha,
Intern at DENIP Consultants Pvt. Ltd.
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