Last year was marked by volatility in asset prices. Equity
markets, currencies and commodities saw ample uncertainty. But long-term
investors know that staying disciplined through short-term noise is what can
have the biggest impact on your attempts to grow wealth. Sample this, at 10%
every year, your money can grow up to 2.5 times in 10 years. But if you leave
it for 20 years, it doesn’t just double to 5 times, rather, it grows 6.7 times.
This is due to long-term compounding.
To become disciplined investors, you have to adhere to some
simple yet rational rules. As we approach the start of yet another financial
year, it’s a good idea to recap rules that can help you with effective
investing.
Set your goal
This may sound boring and even outdated, but it remains the most
critical aspect of long-term investing. No matter what age you are at, goals
are the key. Goals will help you answer the crucial question, why do you want
your money to grow? The answer could be an ostentatious one—to upgrade to a
richer lifestyle—or a functional need—owning a house—or a simple one—to educate
your children. Whatever the desire, only when there is a goal to look forward
to can you efficiently invest money to cater to it.
Suresh Sadagopan, a Mumbai-based financial planner, said, “Goal
setting is important. Without that it is difficult to set a direction. And
without direction, you don’t know where you will end up with your investments.
Ideally, you should prioritise goals after looking at overall financial details
and cash flows.”
You needn’t allocate different products to different goals but
doing an appropriate asset allocation is key. If most of your goals are far in
the future, a higher allocation to growth assets like equity will be more
useful. For example, if you want to save for your three-year-old daughter’s
higher education, the goal is at least 15 years away. At the same time, you may
want to save and invest for your retirement, which is 20 years away. Both these
goals are long-term and can be addressed through equity. But you may want to
keep the products separate to ensure that you remain focussed on each goal even
if the strategy for both is similar.
If, on the other hand, you don’t want to risk uncertainty
because you need assured payouts, you will have to build a mix of fixed income
and equity assets. Say, you aren’t comfortable using only equity because
interim volatility makes you nervous. In such a case, pick a mix of debt and
equity for these goals. But ultimately, for long-term goals, the most efficient
way is to have some amount of growth assets like equity.
Dilshad Billimoria, director, Dilzer Consultants Pvt. Ltd, said,
“After the goals are set and gaps identified, investment products can be chosen
based on risk profile and asset allocation. The tenure of the goal matters when
it comes to choosing products.”
Be regular
Starting a one-year systematic investment plan, investing in
Public Provident Fund for just a few years or even starting a recurring deposit
for just one year and then discontinuing it will not help you grow wealth.
Incremental investments need to be made regularly—every week, month or quarter;
you choose.
If you allocate your money to an investment at a pre-decided
frequency, you are less likely to spend the money.
Second, to grow wealth, money needs to be added bit by bit. Of
course, it’s good to invest a lump sum when you receive it, but there may not
be many such opportunities.
Growth assets such as equity are also market-linked and in the
near term, prices can move up or down. Therefore, investing regularly will
protect you from this volatility.
“We advise clients to shift some portion of their (monthly)
income into a separate savings account and then use the rest for expenses. This
ensures than the investments happens in a disciplined manner with certainty,”
said Billimoria.
Investments are dynamic and so are goals. You have to
continuously evaluate both these aspects—products and asset allocation. Shift
your product preferences if goals change but - be regular.
Diversify
Two years ago, a 3-year fixed deposit with State Bank of India
would have earned 9.25% per annum for you. Only investing in fixed deposits and
renewing them on maturity won’t be wise at today’s rates of around 7.5%. This
doesn’t mean you have to invest in equity or other risky products; rather you
need to be aware of similar products that can increase your effective yield.
For regular income, fixed income mutual funds (both open-ended
and fixed maturity plans), tax-free bonds and corporate non-convertible debentures
are some options that you may consider.
While looking at products, a common mistake is to let taxation
dictate which asset or product you choose to diversify into.
“When you start with goals, don’t focus too much on the taxation
aspect. Think about the overall utility of an investment and how it helps you
achieve your financial objective. Then think about taxation. Sticking to a
product without understanding the tax implication isn’t wise either,” said
Sadagopan.
For example, Public Provident Fund is a tax efficient product.
But for investors who can stomach equity products, long-term allocation here
may not make sense. Here’s why. Equity holdings are tax-free if held beyond a
year. They have also consistently returned above inflation in periods over 10
years. Plus, it is a liquid investment that you can redeem at any time. In
contrast, Public Provident Fund has a lock-in of 15 years.
Similarly, don’t forget to compare post-tax returns. For
example, fixed deposits seem more secure as returns are specified in advance.
But, a three-year fixed deposit earns much less on a post-tax basis compared to
a three-year investment in a fixed income mutual fund even though the pre-tax
yield might look similar.
Don’t diversify for the sake of it; diversification doesn’t mean
you borrow and invest in real estate (investing isn’t the same as buying a
house you want to live in) just to avail the tax benefits. Equally, having
everything invested in equity might not work if you have short-term goals which
are likely to come up in the next 15-18 months.
You must have a mix of different products and asset classes to
have an efficient allocation which addresses all your goals.
Mint Money take
If you are used to putting in a little money every now and then
into a fixed deposit, Public Provident Fund or a mutual fund and own your house
(albeit on leverage), you may think that you invest well and diversify; think
again.
An ad hoc investment approach, more often than not will lead you
to chase the asset (or product) that is most sought after at a given point in
time—be it real estate, equity or gold.
The house you live in isn’t an investment; it’s a need, and if
there is a loan against it, then it’s partly a liability. This kind of a
portfolio may have no link with what you want your money to do for you two or
10 years ahead.
Use the new year as an opportunity to reset your investment
route.
Do check if your choice of investment, assets and products fit
the goals you have in mind. While your asset choices and product choices can change
from time to time, the basics of why you are investing shouldn’t waiver. These
will get defined by your goals and your ability to follow through the
investment plan as closely as possible.
Source Mint
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