Like most things in life, an investment program too has a greater chance of success when you have clear and well defined goals. Goals give you purpose; goals give you direction and goals make you accountable if not to anyone else, then atleast to yourself. So that’s your first mantra of investing – you need to have goals before you venture into an investment. Primarily 3 questions need to be answered
- What do you want to gain from an investment – capital appreciation, great returns or safety and for what specific purpose?
- How long can you stay invested – when do you want to get your money back?
The answers to these questions will automatically decide which investment to pick. If your goal, for eg. is to have enough set aside for the down payment of the new Ford Ecosport by the end of this year, then you will need to invest in a debt mutual fund or an FD as you can’t take the risk of equity in the uncertain political times and the resultant fluctuating markets with such little time for the target date of the goal. If your goal is your child’s education 16 years away, then I would say equity is your best bet.
An SIP in liquid mutual funds (i.e. funds which invest in very short term debt instruments) is an ideal way to put aside money for a short term goal. The 3 years to 7 years window of medium term goals allows you take exposure to risk and you can invest in large cap and comparatively stable stocks and mutual funds along with some debt products. Unless the goal is education, other goals like a home etc. are flexible and you can fit the goal to your investment.
Equity investments are ideal for achieving long term goals along with specific retirement products like EPF, Gratuity, PPF, Superannuation and now the New Pension Scheme NPS. Unit linked plans – child plan, endowment plan or pension plans are also a good instrument to save for long term goals that are atleast 15 years away.
The second mantra of investing right is to do with the timing of it. The early bird does get the worm as far as your investments are concerned – the sooner you start investing, the more it will grow. Remember compound interest versus simple interest from back in school? Let’s do a quick revision.
You have Rs.1000 to invest. The rate of return/interest is 10% p.a. You have two options – earn return using simple interest or compound interest – let’s see what this means
|Time||Amount Invested||Simple Interest Return||Total at the end of the year|
|End of Year 1||1000||100||1100|
|End of Year 2||1000||100||1200|
|End of Year 3||1000||100||1300|
|End of Year 4||1000||100||1400|
|End of Year 5||1000||100||1500|
|Time||Amount Invested||Compound Interest Return||Total at the end of the year|
|End of Year 1||1000||100||1100|
|End of Year 2||1100||110||1210|
|End of Year 3||1210||121||1331|
|End of Year 4||1331||133||1464|
|End of Year 5||1464||146.4||1610.4|
Under simple interest, you calculate 10% on the original invested amount each time while under compound interest, you calculate interest on the original invested amount and the return earned on it each time. So this is what money earning money is all about; what people mean when they say ‘I want my money to work for me’!
While simple interest is easier to calculate, in real life it’s bad for your investment and what makes your investment grow exponentially is compound interest. So longer you are invested, more time your money has to compound.
Rs.2000 invested very month in a scheme fetching an average of 8% p.a. for 5 years i.e. Rs.1.2 lakhs accumulates to Rs.1.47 lakhs during this time.
You have heard of ‘don’t put all your eggs in one basket’? It is the same for your investments. You need to invest in different categories of assets like debt, equity, real estate, gold, commodities etc. so that you can spread the risk. This is called ‘diversification’ and is the third mantra of Investing. If you were invested mostly in equities in 2008, then the mayhem in the markets caused by the US slowdown would have made you poorer by 30-40%. However if only 60% of your portfolio was in equities then instead of a 40% loss you would have taken a hit of less than 25%.
Every asset category has its own use, advantages and disadvantages. So a good portfolio should be a judicious mix of assets – of course having said that, if equity markets are giving more returns one should take advantage and have more money invested there but all of your money there, is not advisable. You need to understand relationships between different asset classes. Traditionally equity and debt have an inverse relationship, so if equity is doing well, then debt is not doing so great and vice versa. Real estate is influenced by both equity and debt but to only some extent. Gold has low correlation relationship with all these asset classes and in fact is the best hedge against inflation and traditionally, has a negative correlation with the US dollar and a positive correlation with the price of oil. Gold is also completely free of credit risk and has always been a safety haven in the event of political uncertainties as we’ve all seen.
The underlying assumption in whatever that’s been discussed so far is that there is an income and a person/persons bringing in this income. But what if something fatal happens to this person and he or she dies? What happens to the loved ones left behind? Are there enough assets accumulated to ensure their day to day living expenses can be met without compromising on their lifestyle? What about education requirements of the children?
Is there a safety net that protects a family from this risk?
Even an accident or illness resulting in hospitalisation and expensive treatment can play havoc with the savings of a family by causing a big dent.
The safety net for all such risks is Insurance – Life and medical certainly but also auto, home etc. This is the fourth mantra of Investing So get a basic life and health cover in place now.
- Life cover should typically be 10 times your annual income + existing loans – existing assets and insurance.
- Health cover should be 3-5 lakhs per adult and 1-2 lakhs per child or get a floater for 5-7 lakhs if you are a family with atleast 1 kid. Even a simple surgery in a decent hospital, costs more than a lakh and half these days. Considering that a cover 3-5 lakhs per adult is justified.
While you may have life cover and health cover through your company and your spouse’s company as well, it is better to have some cover independently. What if tomorrow you move to another company which doesn’t have a large cover or doesn’t cover your family? Or you decide to set up your own company/firm? In all such cases you will be taking insurance at a later stage wherein you may have developed health issue and therefore end up having to pay higher premiums.Last but not the least, seek professional help. With a busy work-life and personal commitments, even if you have a background of finance to understand markets, policies and products, where is the time? Economies world over are increasingly interconnected, Indian economy as far as products and markets is evolving, newer products are being launched frequently and policies and regulations are changing too. In such an environment you need to have time, experience and expertise to handle your portfolio. Often caught up in your work and home routines you need someone to stand on your head and remind you to invest the lumpsum sitting in your bank account or renew your health insurance or guide you on what to do with your bonus. Get a financial planner. But do check this individual or firm out thoroughly because it should ideally be a lifelong relationship, which is possible only if you trust the firm/individual and are comfortable with them. You need to evaluate the planner on various parametres such as:
- Educational qualifications – There are many qualifications these days like CFP, CFA, CIPM which give a planner a good education base to understanding investments and personal finance.
- Experience -What are the clients he currently has? Is he a one man show or part of a firm? Ask for references.
- Ideology and philosophy – Is the firm’s focus on long term planning or short term gains and does that fit with what your objective is?
- Systems- What is the type of service he can provide you?How often will you see a statement of your portfolio? Is there online access? How often will your portfolio be reviewed – is there a system for that?
- Revenue model – Commission based or fee based model as this will impact the recommendations he makes.
- Succession plan – what happens if he decides to not be your financial advisor anymore? Or he moves to another role? Will you have to explain your situation to someone new all over again. You need to exercise sound judgment in selecting your financial planner.
- The author-Lovaii Navlakhi, CFP is the CEO of International Money Matters and The Financial Alphabet.