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Sunday, January 26, 2014

The Right Approach to Investing

The Right Approach to Investing
  • Understand your own risk tolerance (...if volatility makes you nervous then risky investments such as stocks and equity mutual funds may not be the ones for you. You then might as well invest in fixed income instruments instead, such as fixed deposits, PPF, etc.)
  • Ascertain the risk involved while investing (...you see, every asset class - equity, gold, debt and real estate - has risk associated with it and therefore it is necessary to know about the same before investing your hard earned money)
  • Know your investment objective (... It is important to know that there are various investment avenues which are meant to cater to respective investment objectives. So enough care should be taken while investing your hard earned money. Ideally each of your investments should match your investment objectives)
  • Consider your age (...this can help you have the right investment instruments appropriate for your age)
  • Consider the time period before you need money (...Remember: The longer you are away from the time you require your hard earned money, the more risk you can take, and hopefully even earn more by investing in risky asset classes.)
  • Do sufficient research (...It is vital not to get carried away by exuberance and / or what your friends and family say. Instead, undertake solid fundamental research on respective investments, and please do not get caught up in hype....understand how the product works)
  • Evaluate cost of investing (...Remember: gains can be easily eroded if you don't consider cost of investing and thus it is vital to keep an eye on terms and conditions associated with the investment avenue. Very often many indulge in trading in the stock market to make a quick buck without really understanding the associated costs they are paying for regular trading or churning)
  • Aim at investing in investment products that can help you earn more than inflation(...if your investments manage to outpace inflation, it will help you achieve your financial goals smartly and efficiently)
  • Recognise the tax implication (...this is important...after all, the objective is also to earn tax efficient returns. If you do not plan well, you may end up paying higher tax on your returns)
  • Always start early (...as there are benefits of doing so. You can understand it well by taking a look at the following table and chart)

An Early Bird Gets A Bigger Pie

Let us take an example of 3 friends - Vijay, Ajay and Sanjay - All 3 had good jobs and wanted to retire at the age of 60. Vijay being the smarter of the lot, started planning for his retirement at the very initial stage, at 25, and invested Rs. 7,000 per month. Ajay realised the importance of planning for retirement once he was 30, while Sanjay could feel the guilt of being left out only when he was 35. See what they accumulated when they were on the verge of their retirement. 
ParticularsVijayAjaySanjay
Present age (years)253035
Retirement age (years)606060
Investment tenure (years)353025
Monthly investment (Rs.)7,0007,0007,000
Returns per annum10%10%10%
Sum accumulated (Rs)2,65,76,4661,58,23,41592,87,834
(Source: PersonalFN Research)
Disclaimer: The names and figures are fictitious and used for example purpose only.
Also, return per annum mentioned above is for illustration purpose only.


Not only this, they also noticed a wide deviation in the proportion of growth they saw on their invested corpus. While Vijay's money grew around 9 times, Ajay's money grew 6 times and Sanjay saw a growth of just 4 times
Growth in wealth of Vijay, Ajay and Sanjay.
(Source: PersonalFN Research)
Disclaimer: The names and figures are fictitious and used for example purpose only.

Points to Remember for You to Save & Invest Wisely!

(Finally, to wrap-up this session of learning, here are some points one must keep in mind, now that you may have recognised why investing is imperative once you have saved)


To Save
  • Do not splurge all what you earn...SAVE! (...Remember: It is important to economise on your expenses and save for a rainy day)
  • It is never too early to save (...in fact, savings can help you feel financially secure and even sleep better at night)
  • Start small but maintain the regularity 
While Investing
  • Do not rush with investing (...undertake thoughtful research by doing a holistic study)
  • Investing is a serious activity (...in fact, it could be essentially boring, and not exciting)
  • Do not speculate (...while it can be a thrilling experience, it can be killing as well if the tide turns against you. So it is best not to fall for excitement and exuberance)
  • Never use contingency funds to invest (...Remember, they are put aside as part of your savings to meet your requirements on a rainy day)
  • Never invest from borrowed funds (...except in the case of investing in real estate or your own business; but again, while investing therein don't go beyond your means)
  • Know your investment product (...understand how it works and undertake research; recognise the risk-reward relationship the product offers)
  • Diversify (...Remember, this can help you reduce your risk to your overall portfolio if you diversify wisely)
Some Important Ratios to Track Your Personal Finance

Savings to Income Ratio =Total Annual Savings
Total Annual Income

This ratio simply tells you what part of your income you are saving annually. Higher the ratio, the better it is, as it facilitates you to invest and lets your money work for you. 

Total investment to Income Ratio =Current Value of Total Investments
Total Annual Income

This ratio helps you understand the current value of investments done as a ratio of current income. 

At a younger age this ratio tends to be lower. However with time one needs to accumulate enough savings and invest to fulfil various financial goals in life. 

Debt to Income Ratio =Total Debt
Total Annual Income

This ratio would help you evaluate the proportion of total debt as against the total annual income you earn. 

Lower the ratio, the better it is. 

Following these ratios, which you have just learned of, can help you keep a track of your finances.

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Disclaimer

Disclaimer : All information given here is for information purpose only. Users are advised to rely on their own judgement or investment advisor when making investment decisions. This blog is not liable and take no responsibility for any loss or profit arising out of such decisions being made by anyone acting on such advice.