Power Your Money
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Why should you invest? The answer is very simple: to create wealth. And why would you want to create wealth? Well, to fund various financial goals you may have in your life like an expensive TV, foreign holiday, retirement, and so on.
The trouble is that most of us have a single source of income and there are various needs that are immediate, medium term and long term. If we move from one goal to to the other with our accumulated savings, we would be left with almost nothing for our long-term goals. That is why it is important to not just keep money in the savings bank, but use it to make investments that will help you create wealth over a long period of time.
Ram and Shyam are friends, both are 30 years. Ram invests R1,000 every month for his retirement. He manages an annual return of 12 per cent on his investments and succeeds in amassing a neat corpus of a little over R35 lakh at the end of 30 years. Shyam does nothing for 20 years. He suddenly wakes up 10 years before his retirement and starts investing R12,000 every month for the next 10 years. He also manages to pocket an annual return of 12 per cent on his investment. However, at the end of the exercise, Shyam managed to create only around R27 lakh for his retirement.
Ram was investing a measly R1,000 whereas Shyam was investing R12,000 every month. Well, it is possible because of the compounding interest. Some people call the eight wonder of the world because of its power to multiply money over a long period. If you invest in a disciplined manner and give you investments plenty of time, you can achieve most of your goals without much pain. For some academic interest, how much do you think Shyam will have to invest to create a corpus of R35 lakh? Well, he will have to invest around R15,000 per month for 10 years to create that kind of corpus.
If you are still not inspired enough to start your investment plan right away, here is a quick list of habits that stops you from being rich.
Spending months or years to come up with a fool-proof investment plan is not a great idea. There is no guarantee that your perfect plan indeed is going to be perfect. So, start right away.
It is extremely difficult or almost impossible to catch up with someone who has started investing regularly much earlier. Even with a very large investment, you would find it difficult to catch up. Once again, start now.
Try to think beyond a few months or a year. You think of short-term investments only when you have short-term goals. Long-term goals need long-term investments. The basic rule: stick to debt investments for goals that are below three years. Invest in equity if your goal is five years away or longer.
You can't build a large corpus with small investments in debt schemes. If you want anything substantial over inflation, you should invest in stocks. Get rid of the fear of stocks and invest in stocks for your long-term goals.
Don't waste time looking for tips to get rich quick. Most of these tips would do exactly the opposite: rob you a chance of making money on your investments. If you got your basics right, shut out all the noise and stick to your plan. Take our word for it: you would be rich one day.
Getting in and out of investments, especially equity investments, is not a great idea. You would pay higher taxes on such frequent sale and purchases. It also would rob you a chance to make spectacular returns from your investments over a long period. Giving time to your investment is key to create wealth over a long period.
Your first step towards successful investment starts with taking stock of your finances. You should first know your income, expenses, liabilities, savings. Sure, you know all these things vaguely, but that is not enough. You should be absolutely clear about all these things.
Boosting your savings is key to create more money to invest. That is why you should closely examine your expenses, especially discretionary expenses, and figure out how you can cut down on them. Similarly, you should also closely examine your liabilities to figure out the cost involved in servicing them. For example, if you have a huge credit card outstanding, you should first clear that off. This is because it doesn't make sense to pay 40 per cent interest on a credit card loan and earning 12 per cent returns on your investments.
First, buy a health cover for you and family. Two, buy a term life insurance cover if you have financial dependents. Three, create a contingency fund that will cover your expenses of at least six months. These steps will ensure that no unforeseen events will derail your investment plans.
- What are your financial goals?
- What is your investment horizon?
- What kind of investments should you make?
- How much money should you invest?
Don't try to be evasive while answering these questions. If you don't clearly spell out various goals and how much money you would require, you are unlikely to achieve them. This is because a forgotten goal can have a cascading impact on your other investment programme. Similarly, it is also very crucial to get the investment horizon and instruments right.
Quickly open the excel sheet and use the FV or Future Value formula to find out whether you would be able to be achieve the goal. Well, if the investment gives an annual return of 12 per cent per annum, the you would be able to create a corpus of R8 lakh in five years. That means the foreign holiday is very much within the reach.
Your investment horizon should broadly decide your investment choice. Always remember, your short to medium-term goals should be funded by using safe or relatively-safer debt investments. This is because you cannot afford to lose money when you don't have much time in hand. Always invest in bank deposits and liquid funds for goals that have to be met within a few months or in a year. Use bank deposits and short-term debt schemes to take care of goals that have to be met within a couple of years. Always invest in stocks to fund long-term goals. Long-term is five years or more.
Short-term investment options:
They are the safest and they also offer assured returns. However, the trouble with fixed deposits is that the interest is taxed. Use them only for keeping contingency funds, and money needed in the next few months to a year.
They offer slightly higher returns, but they are also a little more risky. Always stick to higher-rated deposits. Do not compromise on ratings for higher returns. Also, never put your entire investments in a single company, spread your investment across a few companies.
They no longer have the tax advantage, but they may still offer slightly superior returns. However, use them carefully. Also, you should find out whether it is worth your while. This is because there won't be much difference in returns if the amount involved is small. It is extremely important that your investment horizon should match with the fund. For example, use liquid funds to park money for a few weeks or months. Ultra short-term funds are suitable to park money for a few months to a year. Short-term funds are ideal to park money for a two to three years.
Long-term investment options:
If you have an investment horizon of more than three years, investments in debt schemes still make sense. This is because long-term capital gains from these schemes are taxed at 20 per cent with the indexation benefit, which is beneficial to those in the highest tax bracket.
If you have an investment horizon of five years or longer, you should pick equity mutual fund schemes. If you are looking to save taxes under Section 80 C of the Income Tax Act, pick one or two Equity Linked Savings Scheme (ELSS) or tax planning schemes. If you are a conservative investor new to the market, pick one or two equity-oriented balanced schemes. Balanced schemes invest in a mix of equity (at least 65 per cent) and debt, and they are less volatile than pure equity schemes because the debt portion offers a cushion in times of volatility. Others can pick up one or two diversified equity schemes to fund their long-term needs.
Investing directly in stocks can be extremely rewarding, but it is also equllay risky. You should attempt it only if you have a sound knowledge about the working of the stock market. You should also have enough time in hand to pick stocks and monitor them.
Tax saving options:
Ideal long-term tax saving option for conservative investors. The contributions to it qualify for tax deductions and interest earned is also tax free.
The best tax saving option for aggressive investors. They have a mandatory lock-in period of three years, but invest only if can wait for more if the market gets into a bad phase.
Yesterday was the best day to start your investments. If you missed it, you should start your investments today. Delay it further only if you want to forgo some extra returns.
Don't worry too much about getting everything right. If you are following the basic rules, you will definitely get it right. It is quite usual for you to feel a bit nervous when you are investing in unfamiliar instruments for the first time. But you will learn on the way. So, don't let your nervousness delay your investments further.
As said before, always try to match your investment horizon with your investment choice. This will help you eliminate unwanted choices, and identify the right ones. It will also save you a lot of headache later. As a rule, avoid risky investments like stocks, equity mutual funds for short-term goals. This is because equity can be extremely risky and volatile in the short-term. You should try to preserve your capital and try to secure stable returns for short-term needs. However, if you have time in hand, you can be a little adventurous and invest in equity. It will help you earn a few extra percentages. This is because equity has the potential to offer superior returns than any other asset class over a long period of time.
Don't forget to review your investments periodically. Investing and forgetting all about it is not a great strategy. You should regularly check how your investments have done over a period of time. Always compare the performance of a mutual fund of your choice with its peers and the relevant benchmark. If you find that the performance is not up to the mark, put it in a watch list. Track it for the next few months and try to find out the reason for its underperformance. If you find reasons to believe that it is not going to bounce back again, sell it. There is no point in continuing with a bad investment because it robs you a chance to make more money elsewhere.
You should also sell your risky investments at least two years before your goal and park the proceeds in a safe avenue. This is to ensure that you have the money safely parked somewhere when you need it.
Useful, simple to understand and easy to execute. Those should be the qualities that your first fund investments should have.
For beginners, these requirements are generally best satisfied by tax-saving funds or balanced funds. Here's why. When you start investing in mutual funds, it makes sense to invest in a fund that invests mostly in equity. The reason for this is that you are likely to have no equity investments at all. Investors at an early stage of their investing life generally have bank deposits, PPF and other fixed-income investments. Since equity is the best form of long-term investment, and mutual funds the easiest and safest way to invest in equity, it follows that the type of fund you choose must be an equity fund. There are two types of funds that are uniquely suitable as beginners' funds. These are Tax-Saving Funds and Balanced Funds.
Tax saving funds are also called ELSS funds as their formal name in the tax law is Equity-Linked Savings Scheme. They are basically all-equity funds, investments in which are eligible for tax exemptions under Section 80C of the Income Tax Act. Under Section 80C, you can invest up to R1.5 lakh in a set of investments, one of which is ELSS funds. Since they are equity funds, one should invest in them for long-term. This long-term imperative is compulsorily enforced because under the tax laws, investments made into these funds are locked in for at least three years. Because of this lock-in, investors tend to have a good experience of getting reasonable returns from these funds. Moreover, the tax-break acts as a natural boost to returns.
Balanced funds, also called hybrid funds combine equity and debt investments in a certain ratio. In order to maintain this ratio, the fund manager will typically disinvest from holdings that have gained more and invest in holdings that have gained less. This, of course, is asset rebalancing.
Effectively, the gains that are made in equity are protected by debt. The great advantage of balanced funds is that they are inherently safer than pure equity funds. They gain well when the markets gain but when the markets fall, they fall less sharply, thus protecting the gains that were made in the good times.