Did you know that as you read this article, your fixed deposit is actually losing money?
Currently, savings account/ FD interest rates are in the range of 3.5 to 5 per cent per year. Industry experts say inflation this year will be approx. 7 per cent. This means that although your money grows from 100 to 104 this year, your expenses will grow at a faster pace. ‘Cash is trash’ is a famous saying in the markets for this reason – your cash generates negative real returns for you when inflation is high.
Kanika Agarrwal, Co-founder, Upside AI says, “Thinking, learning and talking about money is a boring/ intimidating task for most of us, which is why we end up procrastinating on this most important aspect of our life. Hence, our money sits in the bank losing its value.”
The most important aspects of saving and investing are: time and the magic of compounding. Therefore, Agarrwal says, “it is important to become financially literate to understand how to save, set goals, where to invest, what to buy, how to benchmark the returns.”
How should you get started?
Step one is budgeting and saving. Irrespective of age, gender, or professional background, saving and budgeting is a skill everyone should know about. Agarrwal explains, “Essentially step 1 is building your own personal profit and loss account where you track your income, expenses and savings.”
The next step is to buy insurance – health and term. Insurance is not supposed to be an investment product but a safety net. Agarrwal points out, “Therefore, stay away from endowment plans and ULIPs and focus on solving for worst-case scenarios which is what term and health insurance do for you and your family.”
The next step, experts say is investing that money. The decisions you make to invest are (1) asset allocation (2) stock selection; and (3) market timing.
Of the three, asset allocation, Agarrwal points out, “will always have a disproportionate impact on one achieving their financial goals.” Asset allocation is essentially deciding which asset classes you will invest in, i.e. equity, debt, gold, real estate, etc.
Once you know what you are able to save every month, you need to spread it across different assets. Experts say this is important because in any given year, a different asset would do well – equity, debt, gold, real estate, etc. When you hold a balanced portfolio, you ensure reasonable returns without too much volatility in the portfolio.
For instance, what if you bought only stocks and mutual funds? You would do very well in say 2021 – but your portfolio would have fallen 20-30 per cent in March 2020. On the other hand, if you added other assets, you would see a more even curve on how money is growing.
Agarrwal says, “Broadly generalizing, the younger you are, the more risk you can take. Therefore, you can perhaps invest more in equity (ETFs, mutual funds, stocks) and less in debt (fixed deposits, liquid funds).”
Choosing what to buy
After that, comes choosing what to buy. When investing in equities, try to choose products which give you a diversified portfolio – for example, according to Agarrwal, you could buy a NIFTY index fund, a mid and small-cap fund, or an international fund.
For debt, experts say, it is always a good idea to max out your public provident fund because of its lucrative interest rate and tax exemptions. Agarrwal adds, “The RBI has even allowed retail investors to buy government bonds directly through net banking. For money needed in the short term, fixed deposits and liquid funds work great. A good rule of thumb is having six months of expenses in liquid funds for emergencies.”
For gold, there are gold ETFs which are liquid. Another great option is sovereign gold bonds (SGBs) that the RBI issues regularly – these have a favourable tax structure and give an additional 2.5 per cent interest per year. However, these have an 8-year tenure and therefore the money is locked in.
Real estate is now accessible in bite-sized units by way of Real Estate Investment Trusts (REITs) which are like mutual funds in their structure but instead of stocks, the pooled vehicle buys real estate and pays out the rent it earns from those properties as dividends.
This is why, Agarrwal explains, “financial literacy is so important – because asset allocation is not a static concept. It constantly evolves with one’s stage in life, one’s liabilities, responsibilities and income stream. Further, there are always new products that are being added that one must try and educate oneself on regularly.”
For instance, in the last few years, many investor-friendly products have come to market for retail investors like exchange-traded funds, SGBs, REITs, international funds, and government bonds.
Agarrwal further adds, “It’s also important to mention that investing is not a race. Your only goal with investing is to make sure your money compounds well for your goals and not to beat your peers/ colleagues/ friends.”