Here is a simple plan that will put you on the road to financial freedom
The Economic Times, 21st March 2013.
When you begin to earn money and want to invest, it is never too easy to find right advice regarding where to put your money so that your corpus grows and you are able to meet your life's major financial goals. Here are a few basic pointers for beginners and those with a moderate-size corpus. Ø PAY OFF DEBT
Before you can begin your investment journey, get rid of any expensive debt you have accumulated. Personal loans and revolving debt on credit cards are pernicious as they carry high interest charges.
Ø CREATE A CONTINGENCY FUND
Have at least six-eight months' monthly household expenditure saved in a contingency fund before you begin your investment journey. A small part of it could be saved in a savings account where it is easily accessible. The rest could be put in a liquid fund from where it can be withdrawn in a day.
Ø SAVE DILIGENTLY
A person should ideally save 25-30 per cent of his gross salary every month. Adopt what is known as the “pay yourself-first” approach. Take out a portion of your earnings and invest it at the very beginning of the month.
Ø DETERMINE YOUR ASSET ALLOCATION
Asset allocation refers to how much of your investment portfolio should go into equities, debt and gold.
- Your asset allocation should be decided on the basis of your age: 100 less age is the portion of your portfolio that should be invested in equities. If you are investing for retirement, you could have a higher allocation to equities.
- If you are a very conservative investor you should have a lower allocation to equities.
- Finally, your asset allocation should also be determined by your current level of savings and earnings. Invest in mutual funds. They offer the advantage of diversification (a typical diversified equity fund invests in anywhere between 15-70 stocks across many sectors). The actively managed funds have a fund manager who is in turn supported by a research team.
- The equity portion of your portfolio should be filled up with diversified-equity funds (avoid sector/thematic funds or have them in a very small quantity). This portion should in turn be split between large cap funds and large- and midcap funds (which should together make up 70-75 per cent of the equity portion of your portion) and mid- and small-cap funds (25-30 per cent).
- When choosing a diversified equity fund, look at past returns--both rolling and calendar year returns. The fund should have beaten its category average over most time horizons (six-month, one year, three-year and five-year). Also look up calendar year returns to ensure that the fund has beaten its benchmark in at least four of the past five calendar years.
- Next, ensure that the fund's level of risk (beta, standard deviation) is lower than average and risk adjusted returns (Sharpe ratio, Treynor ratio) are above average.
- Finally, make sure that the fund manager who earned those returns (over the last three or five years) has not moved out (because if the fund manager has changed, the past track record holds no meaning). If you find it difficult to check out all these parameters, choose funds based on their star ratings (offered by rating agencies such as Morningstar, Crisil, ICRA, etc).
- If you don't want to be bothered with choosing active funds and monitoring their performance, invest in a passive fund, an index fund or an exchange-traded fund which offers the advantage of being low-cost products.
INVESTING IN STOCKS
- Under most circumstances, investors are better off investing in mutual funds where they get the advantage of diversification and expert fund management.
- With a limited amount of money, it is difficult for most investors to build an adequately diversified portfolio of stocks.
- Moreover, most investors lack the knowledge and expertise required for stock selection.
- Expert fund management also calls for access to a database of companies (annual subscription to which costs about Rs 75,000 per year).
- Moreover, fund managers at mutual funds have access to company management. They speak to them regularly and are the first to know about a development, positive or negative, at a company.
- If you are keen on investing in stocks, set aside a small sum of money (apart from what you invest in other investment instruments) for investing in stocks.
- Look up the stock's vital statistics: growth in revenue, operating profits and profit after tax over the last three to five years. Check out its level of debt (shouldn't be too high). Check out return ratios such as return on equity and return on capital employed. Choose a stock that has the better numbers. Furthermore, make sure that the stock you are considering is available at an attractive valuation (low PE, PB, and PEG).
All the above checks establish the stock's track record. Next, go through its annual report (particularly management analysis). Finally, lay your hands on a few recent reports issued by brokerage houses on that stock. Together with the annual report, these brokerage-house reports will give you a good sense of whether the stock enjoys sound prospects. Only if all is well should you invest in the stock with a horizon of at least three to five years. - Every six months, check to ensure that all is well with the stock.
- As you can see from the above, investing in stocks requires time and effort. It should only be undertaken if you have the required knowledge, expertise and time.
INVEST IN DEBT
It is important to have debt/fixed-income products in your portfolio. They help diversify your portfolio and also lend greater stability to it (debt products don't fluctuate much; returns from fixed-income products remain constant). - If you are a salaried employee, you would be contributing to employee provident fund (EPF).
- Another product that can be used for the debt portion is Public Provident Fund (tax-free returns and Section 80C tax benefit available).
- You could also look at debt funds (an income fund or a dynamic bond fund with a good rating).
- Fixed deposits, monthly income plans (growth option) and fixed maturity plans of mutual funds could be used for shorter time horizons.
INVEST IN GOLD
At least 8-12 per cent of your total portfolio should be invested in gold. Having gold in your portfolio will provide further diversification and lend stability. Gold acts as a good hedge against inflation. It also does well in times of economic adversity. Invest in gold bars or coins which can be easily sold off in case of a financial crisis or invest via a gold exchange traded fund (ETF), which has the advantage of low cost. Avoid complicated products that are being hard sold to you. In all probability, they are high-cost products that will enable the seller to buy a yacht but will harm your finances. And lastly, begin investing early.
Ø BUY INSURANCE
As soon as you begin to earn and have dependants buy life insurance cover. Avoid buying insurance-cum-investment products like unit-linked insurance plans. Instead, opt for a pure term cover. The sum assured should be 10 times your annual gross salary. If you buy a term policy at an early age, you will be able to get a large cover at a cheap rate. Buying an online policy will also enable you to get the policy at a lower price.
Ø INSURE YOUR HEALTH
Even if you have been provided health insurance by your employers, buy an individual cover as well for yourself and your family members. This will ensure that you are not left without a cover in case you lose your job, or if you fall ill when you are between jobs. Later, you may supplement these individual covers with a family floater. As you age (after 40) buying critical illness policies also becomes important. Buying insurance at a later age becomes difficult. Many of the ailments that you acquire as you age will be classified as pre-existing diseases for which you will not be covered for the first four years of your policy.
Disclaimer : The information contained in this report has been obtained from sources considered to be authentic and reliable. However, we will not be responsible for any error or inaccuracy or for any losses suffered on account of information contained in. Mutual Funds and securities investments are subject to market risks and there is no assurance or guarantee that the objective of the Scheme will be achieved. Past performance of the Sponsor/AMC/Fund or that of any scheme of the Fund does not indicate the future performance of the Schemes of the Fund. Please read the Key Information Memorandum and Offer Document carefully before investing.
Posts
