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Golden rules you must not miss! Here is why you need to start investing early

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New Delhi | Published: June 27, 2018 1:07:35 AM

Whatever the circumstances, do not let greed guide the decision of asset allocation. At the same time, even fear should not guide the decision making in asset allocation.

The relevance of a financial plan can be fully understood when one starts to put his entire future in perspective, emotional as well as financial.

While most Indians have always been serious savers for a long time, they do not accord the same priority to investing. Most confuse savings with investments and fail to understand that savings is what is done for the short term while investing is for the long term.

In order to make your savings work, you need to channelise them into various avenues which can grow at an expected pace and earn returns in the long run. Simply parking the funds on an ad-hoc basis is not going to work. The relevance of a financial plan can be fully understood when one starts to put his entire future in perspective, emotional as well as financial. The young have to plan for their entire life, the middle-aged for their retirement.

Planning funds for various stages

Ideally, one must keep enough emergency funds to cover at least 3 to 6 months’ worth of living expenses. The money should be parked in liquid funds of mutual funds which can be available instantly. Once that is taken care, then one should look at building a corpus which will be needed for expenses to take place for medium term goal (3-5 years) and long-term goal (10 -20 years). For medium-term goals such as buying a car, going for an exotic holiday or buying an expensive accessory, the investor should look at moderate risk investment options like balanced funds, monthly income plans and long-term bank deposits.

To build such a corpus one must start early. For instance, A and B have known each other for long. A started investing Rs 10,000 every month at the age of 25 while B started at 35. At 55 years of age, when both plan to retire, A’s corpus would be Rs 2.27 crore, assuming returns of 10% a year while B would have just Rs 76.50 lakh. This is the power of compounding. Equity should be the preferred asset class to achieve these goals.

Mutual fund SIPs

Mutual funds’ systematic investment plan (SIP) allows an investor to buy units on a given date each month. One can start with a minimum amount of Rs 500. The biggest advantage of an SIP is that the investor does not have to time the market. Investing every month ensures that one is invested during the highs and the lows. To have the advantage of compounding—one must start investing at an early age as longer the investment horizon, the bigger the benefits. If you start early, equity funds should constitute around 80% of portfolio as this asset class has been found to be the best bet for growing money over the long term.

To be sure, SIPs make the volatility in the market work in favour of an investor and help average out the cost. For instance, with Rs 1,000, one can buy 50 units at Rs 20 per unit or 100 units at Rs 10 per unit, depending on whether the market is up or down. More units are purchased when a scheme’s net asset value (NAV) is low and fewer units are bought when the NAV is high. When the two situations are analysed together, the cost is averaged out and, the longer the time-frame of the investment, the larger will be the benefits of averaging.

Diversify investments

Diversify your investments for better risk-adjusted returns. Risk, time horizon and liquidity are important parameters. The longer the horizon, the higher the probability of compounding returns in equity and real estate. Most investors confuse tax planning with investments. Tax efficiency is an important consideration while investing in various asset classes.

A periodic review of a fund’s progress towards the set goals is important. Whatever the circumstances, do not let greed guide the decision of asset allocation. At the same time, even fear should not guide the decision making in asset allocation. Look at the time horizon, liquidity needs and company fundamentals closely before investing in volatile times. The golden rule that one should follow is to invest with a time horizon after taking into account the cash flow and liquidity needs along with asset allocation. Such an approach will be the key for wealth creation in the long-run.

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