Unless you know what your financial goals are, you can't determine how much to save and where to invest to reach the goals on time by taking minimum risks.
Saving money is a good habit. It is also important to invest the money saved to get some return. But investment is not just about saving and return benefits. Unless you know what your financial goals are, you can’t determine how much to save and where to invest to reach the goals on time by taking minimum risks.
Generally, most people start asking about aimless investments when stock markets reach near the peak during an upcycle, giving the existing investors a return superior to the fixed-income instruments.
Investing in stocks while the markets are on fire, however, puts the investors at a very high risk, as the down cycle becomes imminent once the markets reach the peak.
Once the markets hit the down cycle, such aimless investors, who entered the markets for just return benefit, get panicked after seeing their investments at a loss and redeem their investments, thus converting the notional loss into actual one.
To avoid putting yourself in such a situation, it is very important to do proper financial planning before investing.
For investing in a proper way, you need to do the following:
Identify Financial Goals
The first step is to know why you need to invest. For this identify the life goals – like marriage, child education, buying a car, buying a house, accumulating retirement corpus etc. Once the goals are identified, quantify them in financial terms. For this, the following factors to be taken into account.
Current Expenditure: Determine the current expenditure needed to fulfill a life goal. For example, if you want to get your child admitted to a medical college, determine what the current cost of pursuing a medical degree is.
Time Gap: Determine the time gap, i.e. after how many years the event will take place. For example, if your child is 5 years old and will take admission for the medical course at the age of 18 years, the time gap will be 13 years.
Rate of Inflation: Take into consideration the rate of inflation that would inflate the expenditure at the future date. For example, if the current expenditure to pursue a medical degree is Rs 10 lakh and the rate of inflation in the education sector is 10 per cent, the degree will cost over Rs 34.5 lakh after 13 years.
The process has to be repeated for each financial goal.
Calculate Current Investment
Once it is determined how much money will be required after how many years to fulfill each financial goal, calculate the value of your current investments. Higher the current investments, lower will be future investment needs and need to take undue risk to meet financial goals.
How much to Invest
Once you know how much money will be needed after how many years and how much investment you currently have, you may calculate how much more you need to invest at what rate of return to fulfill the financial goals on time.
Where to Invest
Where to invest will depend on how much return you need to generate on future investments to meet each financial goal after the specific duration. If your resources are limited, you need to invest in a financial product that gives higher return.
But remember, to get higher return, you may have to take higher risks and invest in equities. On the other hand, if you have higher current investments and capacity to invest larger amounts, you may reach your goals by taking lower risks and investing in fixed-return instruments.
Investing in Equities
As investments in equities and equity-oriented products like Mutual Funds (MFs) face market volatility in short term, you may take the calculated risk for long-term financial goals only.
Such investments will be governed by long-term market returns and fulfillment of future financial goals and not by intermittent market volatility and fluctuation in notional gains/losses.
So, a planned way of investment would provide you conviction in the power of equity and would help you weather the market volatility and generate a superior return in the long term to fulfill your financial goals.
However, the risk appetite of investors also plays a big role in the decision to invest in equities.