Inflation: You are not spending the same amount of money today as you used to spend two years ago for purchasing the same goods and services you are spending more. The obvious reason is that prices have increased over the period. Prices rise over time due to inflation, and this can erode ones returns. For example, if a fixed deposit returns 8% and inflation is 6%, the real return that one makes is only 2% (i.e., 8-6%).
Inflation can also affect ones savings goals and impact the investments required to reach this goal. This is because the prices of goods and services go up over time. For example, if one wants to take a foreign holiday in three years, and assumes that the required amount is R3 lakh without taking into account inflation, the actual cost will be much higher. Hence, it is crucial to factor in inflation into ones financial plans to ensure that savings and investment beat inflation.
Taxes: Another important factor that people forget while making a financial plan is their tax outgo it is always advisable to choose an investment that gives good returns at a low tax rate. The final return is called tax-adjusted return, and unless this figure beats the rate of inflation, the investment will not yield any real returns over the long term.
One can make use of Section 80C, which offers a maximum deduction of up to R1 lakh on investments such as Public Provident Fund, life insurance premiums, NSCs, equity-linked savings schemes and fixed deposits of five years with banks and post office. These investments can be used to offset taxes to ensure that one earns better overall returns.
Portfolio selection and monitoring: One of the most important aspects of achieving ones financial goals is to select and invest in appropriate assets. To do this right, one should study their risk appetite and, depending on this and their goals, invest in various asset classes. For example, someone who has a low risk appetite and requires money in a short time can invest in debt funds whereas someone who has high risk appetite and requires funds only in the long term can invest in equity assets.
For example, if your financial goal is to send your child abroad for studies in a year or two, you could invest a portion of the money in tax-free instruments like PPF to ensure returns and save taxes. Investments in PPF gives tax-free fixed interest rate, principal security and income tax deduction. In cases like this, it is not advisable to invest directly in equities with the money set aside for your childs education as there is a lot of uncertainty in stock markets and one could end up losing the invested money. Debt instruments would be safer.
It is advisable to invest in mutual funds through systematic investment plans (SIPs) as this route ensures that one doesn't need to time the market. The investment in SIP happens each month irrespective of the market condition hence, individuals can benefit from both upcycles and downcycles. Always link you investments to goals and have a long-term view for building a corpus.
The writer is chief executive officer, Right Horizons