Investing is something that even the otherwise knowledgeable people mess up and even people who are excellent in their own fields get this wrong.
Here is a simple basic, no-nonsense guide to get you started. I hope this helps. Though the avenues and examples are more for Indian context, the facts and the principles are universal.
Any such article/session are indicative and general in nature and none of these should be followed blindly. This is because each one of us has individual circumstances, needs and therefore, these rules may not necessarily be suitable for everyone to be followed blindly.
I am NOT a certified investment advisor, I am sharing my learnings over the years purely for educational purpose and no, I am not an agent of any company.
“Every Penny saved is every penny earned” is probably the most under rated statement.
Here is a list of items that I have learned over time:
- Do NOT have high cost debts. For example Credit card debts are one of the worst things to have.
- Prepare a budget, stick to it.
- Provision for yearly expenses like car, health insurance, life insurance premiums, home trips, vacations, Etc.
- Understand the difference between wants and needs. One generation old Phone may be as good as the latest one for most of your needs at a much lesser price.
- Look out for offers and discounts when doing big purchases.
Saving — Setting money aside — as cash or near cash avenues.
Investing — An asset that you anticipate to get returns from.
Returns — The interest rate at which your money grows.
Inflation — The rate at which things get costlier as time goes.
Risk —In simple terms, what is the risk of losing the money you invest.
Bond—A loan that a company or Govt. takes from you with a promise to return with X% of interest.
Holding for Long Term — Not measured in days, weeks, or months. Measured in years, preferably at least 3 years for debt instruments and 5 years for equity instruments.
Capital Gain Tax — A tax, a surcharge and cess on top of that, charged by the Government on the gain on capital you make in investments, there is a Short term one and a long term one, duration and rate varies depending on the type of the investment.
Liquidity—Like Liquid, when it is very liquid, it easily flows, easy to take it when you need it, readily available. Like Cash, near cash instruments. When there is a lock-in period like a FD or tax saving Mutual fund then it is not so liquid.
Insurance is NOT investment
One of the most common mistakes that Indians make is treating Insurance as Investment. As the name says, Insurance is Insurance. It is to be used for unforeseen circumstances. The best way to approach life insurance is to buy a Term insurance plan for the earning member(s) of the family and make sure that the amount insured is fairly equitable to the income generated. Do NOT buy ULIPs, Endowment plans, Money Back Plans Etc. They are usually meant to make the Insurance company and the agents richer and not you. The cost and commission structures of some of these products are abnormally high and you would lose. They also provide very less life cover, which would add to the agony of losing someone.
Health Insurance was always mandatory and this pandemic has made it something that we cannot live without. Make sure to have enough cover for you and the family. The earlier you enroll, the lesser the premiums are and make sure to read the fine print like exclusions, co-pay, waiting period before picking one. For people with comorbidities and for Senior citizens, health insurance costs a bomb and is difficult to even get one, however do not let it be a reason not to buy the cover. Even if you have a cover from the Government or the Employer, it is always safer to have a basic health insurance cover to account for policy changes, job switches, Etc.
The first thing to do is to build an emergency corpus — the money that you would need when something unfortunate and sudden happens. Think of a sickness, an accident, a job loss or a business slowdown (like it happened in a pandemic). This is the money that is going to take you through these tough times. The usual thumb rule is to keep six times your monthly income (assuming that in 6 months things go back to normal), but after the COVID pandemic the experts agree that this needs to be at least 12 months worth. Some part of this money should be liquid, cash or cash equivalents and some part of it can be placed in the sweep-in fixed deposits provided by many of the banks and in short-duration debt funds.
An investment goal is very simple. What is that you are investing for? As simple as:
- Child’s Higher Education
- Down Payment for my Home
- A family trip to Europe
- Retirement Funds
As you can see here, the duration and the money required for each of these are very different and based on that you plan your investments. The question to ask is how much money do I need for my Europe family tour and when do I need it? — This will give the amount of money you need to save and the asset class you should go with. For example, if you want to accumulate 25 Lakh in the next 10 years, for your child’s higher education, and if you already saved an amount of 50,000 saved, then you would need to invest around 11,000 per month in an instrument which earns an annual returns of 11%
If we have decided to start investing, we need to know what all are the different asset classes available for us. The following image shows different asset classes that are available with some examples.
Cash instruments carry the lowest risk, your capital is protected but the returns are negligible. In the long run, even in a couple of years your cash starts losing value and though numerically it may remain the same, inflation makes them have lower purchase power and in turn they are unattractive as an investment option. This should be used only for immediate goals, coming up in an year or lesser and for some chunk of your emergency corpus.
Fixed instruments have better returns than cash instruments and are carry a slightly higher risk depending on the investment avenue. Indians love these fixed-income instruments, and majority of people have majority of their financial savings in bank FDs, PPF, post office deposits, NPS and such. There are also schemes specific for Senior Citizens which offer a little more return than the normal FDs. The tax rates on these and the stagnant or worse, the decreasing interest rates on these investment avenues is eating up a lot of investor wealth.
There are also Government and Corporate bonds, which take money from you for a promised interest rate. They carry an associated risk, there are ratings for such corporate bonds. AAA is the highest rating an instrument can get. There are also debt mutual funds which invest in such instruments and take the headache away from you. They are managed by professional fund manager and they have typical charge structures that you pay.
Debt Mutual Funds as of now also offer an additional benefit by way of indexation over Fixed deposits when held over the 3 years. The tax difference is there because fixed deposits are classified as interest income while mutual fund returns are classified as capital gains. If it is an interest income, you are forced to pay tax every year for the interest you earned that year. If the total interest income from a bank exceeds Rs. 10,000, there is a TDS deducted at 10%. This in turn means that some part of your money is not adding to compounding.
Here is a screenshot from Value Research, showing the returns of some of the best performing debt mutual funds over last 5 years. Note: This is NOT a recommendation. Do your own research, Learn before you go into any investment avenue.
Equity instruments usually refer to Stocks and Mutual Funds which in turn invest in stocks. Equity markets time and again have proven to be one of the best performing asset classes, across the world and in India. Equities carry a higher risk than fixed instruments and are very volatile. They have a tendency to go up faster and go down faster too and it is staying invested over a long period of time that helps to tide over this volatility.
To understand Equity investments better and to better, there are two concepts that we need to understand better.
Compounding: Yes, the concept that we studied in 8th grade mathematics. Compounding helps, to earn more. Money yields money and in turn, yes you guessed it, it yields more money. This works opposite of EMIs that we pay for loans. It helps you accumulate wealth. The earlier you start, the better. Here is a simple table that demonstrates how compounding works.
It does not matter how much, there was a time when we could not invest less than 5,000 or 10,000 in Equity mutual funds. Today they allow you invest as low as Rs. 500. Whatever you can, start now. Do not wait to earn more to save more, it usually works the other way around. Money earns money. The more you save, the more money you earn. Start with investing at least 10% of your savings.
SIP: This is the concept that makes equities palatable. This helps you to ride the risk with equity investment in a much safer way. SIP or Systematic Invest Plan helps you do something called Rupee Cost Averaging. SIP is nothing but investing a regular amount in a regular interval, as simple as let us say investing 2,000 every month in one or more mutual funds every single month, no matter what where the market is and no matter what what your financial situation is.
As we saw, equity markets are volatile and they go up and come down and the trick is to ride the entire cycle. When you stay invested for 5 years at least via the SIP route, it is extremely rare that you will lose money in Equity markets.
Equity mutual funds take away the risk of direct stock investing as many of us are not Pros in stock picking and we pay the Fund House a charge for doing this for us. There are various types of equity mutual funds, depending upon the geography, index, sector, stocks and the market capitalization of the stocks they invest in. We will see more of this in the next article/session.
Stocks are for the people who know what they are doing and who have a higher risk appetite. We will see more of this in the upcoming articles/sessions.
Commodities are one of the oldest asset classes for Indians, given that almost every Indian house hold has physical Gold as an asset and it is nothing but a commodity. Likewise there is silver and other precious metals and even the day to day agricultural commodities are traded in commodity exchanges just like equities. Once again, there are funds which specialize in commodity investment and their returns are very closely linked to the price of commodities for example there are some world mining funds which invest in Mining companies. There are also Gold ETFs, Gold Mutual Funds, Sovereign Gold Bonds and other such instruments which are much more liquid than physical gold.
Real Estate This again is one of the most common assets that Indians have. An Indian arrives in the financial and social scene when he has his “own” home. The first home is probably essential and it is advisable that if you take a home loan it should not exceed 30 per cent of your monthly income.
Buying/building more homes than the primary one for rent yield is not really as straight forward as it sounds. More often than not, equity as an asset class will always win over this and it is something that you really have to consider before doing so. Here is an illustration from Money Control that shows the yield is probably less than even Fixed Deposits.
Now that we know the avenues we have, we need to get the asset allocation right. Asset allocation is having a clear cut strategy and knowing what works for you. Each of the asset classes above has different level of risk and different level of returns.
In short, as thumb rule, (100 Minus Age) is a formula that people advise you to have for equity exposure. So if you are 30, you can easily have 70% of your investments in Equities and the rest in fixed income. Keep a note of your gold, real estate investments too and make sure that there is not too much concentration in any one of these asset classes.
Markets may change, jobs may go, accidents may happen but having a clear cut understanding of your goals, investing towards them, term insurance cover along with a health insurance cover and finally an emergency corpus will help any of us tide through these unforeseen circumstances.
TO re-iterate, these are my learnings and I am not an investment advisor. Always do your own research, it is after all, your hard earned money.
Coming up in next parts: Equity Mutual Funds, Basics of Stock investing.