The 'Do-it-Yourself' approach is ideal if you want to take full control over your financial future and operate with a focus on process rather than on products and people.
So, you are young and you are techno-savvy too. You also want to maintain control over the financial planning process from plan creation to implementation. Then DIY investment is just for you. The ‘Do-it-Yourself’ approach is ideal if you want to take full control over your financial future and operate with a focus on process rather than on products and people. The whole approach of a DIY investor is to leverage the power of technology to get the right investment answers. But that is easier said than done! Is there a rule book that the DIY investor can adopt to increase the chances of success of the DIY approach? While you cannot have a rule book, you can surely have some golden rules of DIY investing. Here are 5 such rules that make a success of your DIY investing dreams:
1. First, have a clarity on the length and focus of investment
Financial planning is all about starting with the end in mind. Why do you invest? You invest because you need to create wealth. Why do you need to create wealth? Ok, you have to play for your retirement, your child’s education, spend on creature comforts etc. That is how the DIY investor must begin the process. First the goals need to be identified. Then the goals must be classified into time buckets and then the investment must be tagged to each of these goals. That makes the process granular and a lot simpler too.
2. Appreciate the importance of diversification
If you are a DIY investor, then you cannot miss the importance of diversification. The whole of idea of diversification is to spread your investments cross asset classes so as to reduce your risk. As a long term portfolio planner, your focus should be to create a solid diversified portfolio and manage the risk of the portfolio. The returns will take care of itself and there is little that you can or need to do about that. Diversification happens at two levels. There is the asset class diversification where you spread money across debt, equity, gold, liquids etc. Then there is granular diversification where you spread your risk across equity sectors, equity themes, debt ratings, debt maturities etc.
3. Your focus must be on optimal risk approach to investing
What do we understand by optimal risk approach? The idea is that your endeavour must be to minimise risk for a given level of returns or maximize returns for a given level of risk. That is what optimal allocation is all about! But how do you assess risk? Firstly, you look at your risk appetite. Your risk appetite is predicated on factors like your age, your income levels, your liabilities, nature of your job, market cyclicality etc. It is based on your risk appetite that your risk tolerance is determined. As we said earlier, the focus at each step must be purely to minimize risk. Returns will take care of themselves. Risk is what you can control!
4. Understand the fundamentals and balance in your equity and debt ratio
Having identified your goals and understanding that focus should be on risk mitigation, the next step is to actually build your portfolio. You have a variety of asset classes and you need to peg these asset classes accordingly. Your equity component must be higher in the earlier stages as you need to make the power of compounding work in your favour. As you grow older and approach your goals, you need to bring in the safety and security of debt into your portfolio. Equity is more wealth creating in the long run but it is risky in the short run. Debt is lower on the risk scale and also more stable in terms of predictability of returns. But the capacity to generate returns is limited. It is up to you and your robo advisor to strike the right balance with the help of big data and sophisticated algorithms.
5. It is a game of trust and you must trust your Robo Advisor
This is the unsaid part. When you are planning your long-term investments and using the power of technology, you need to trust your robo advisor. Of course, you can do the necessary tests and ask the necessary questions before deciding to adopt the robo advisor. Having done that, you next task is to trust the robo advisor completely. Do not get carried away by news clippings and articles. You are, in a way, in a long-term relationship with the robo advisor and you need to trust the robo advisor fully. That is the key!
(By Vaibhav Agrawal, Head of Research and ARQ, Angel Broking)