The best investors in the world didn’t figure it all out in one day. Studying the financial marketplace, figuring out your personality; all this takes time and a lot of patience. And don’t forget making a note of all the mistakes made along the way. They’re meant to be learned from, after all.
Here are some guidelines based on common sense (and supported with examples) that will improve your investment success, irrespective of your level of financial sophistication is. Worth a read, huh?
Start early and stay late!
What we mean to say is, begin investing as soon as you can! Be patient and time will help your investments show compounded growth. Don’t believe us? Take a look at the two scenarios below.
Let’s start with an assumption!
Scenario I – Your parents start saving Rs.5,000 per month for you from the time you are 15 years old. After 15 years, you stop putting money into your nest egg.
Scenario II – You start saving Rs.10,000 per month from the time you are 30 and continue investing till you are 60.
In both cases, let’s say, you earn 10% post-tax return per annum on your investments. In which scenario will you have more wealth when you retire at age 60?
The answer is, Scenario I. Surprised?
Here’s how: Your Rs.5,000 monthly savings between age 15 and 30 will aggregate to Rs.3.6 crore by age 60, whereas, in scenario II your Rs.10,000 monthly savings between age 30 and 60 will aggregate only Rs.2.28 crore. The advantages of starting early are obvious!
Discipline =Better returns!
Be systematic with your investments. Each month, invest as much as you can afford, and hike up your monthly investments whenever it is possible. If you’re smart about it, not only will you spread out the risk involved, you will benefit from compounding as well.
Let’s take the example of Mutual Funds. Putting in a fixed amount every month doesn’t imply fixed units. The number of units you actually get will depend on the Net Asset Value of the fund. So, using the fixed sum of money, you will buy more units when the market moves down and fewer units when the market goes up. E.g. If you invest Rs.2,000 a month in a Mutual Fund at a price of Rs.20 a unit, you will have bought 100 units (2,000/20). But at a price of Rs.10 per unit, you can buy 200 units (2000/10). This means you are averaging out your cost. You also get the benefits of compounding!
Variety is the spice of investing
Diversify, diversify, diversify! We can’t say this enough. Spread your investments across different financial vehicles according to your needs. If you anticipate needing money soon, then invest in liquid investments, but when investing for the long-term, invest as much as you can in stocks and bonds. Or, invest in Mutual Funds. These are the ultimate investment products where diversification is inbuilt! As you build your portfolio, you should strive to diversify it some more. This, you can do, by choosing Mutual Funds which have varied objectives or styles.
Let us explain. Each individual asset class has its own risk and returns characteristics, and behaves differently under various economic conditions and market cycles. Diversifying investments across asset classes is considered to be one of the most effective ways of reducing risk. This will help create a portfolio with reduced risk and greater return potential.
Understand your risk profile and periodically monitor your portfolio to make sure that it is balanced. Once you have decided how much to invest in each type of asset, rebalance often so that you stick to the original percentages you had decided on, particularly after a large market shift, upward or downward.
Let us look at a scenario, where you have created an asset allocation of 50% in equities or equity related instruments, 40% in fixed income instruments and 10% in cash and liquid funds, with a total corpus of Rs.50 lakh. Let’s say your equity portfolio has performed well and the Rs 25,00,000 invested in equities has grown to Rs 40,00,000.
During the same time period, your fixed income portion has returned 9% and your cash portion has returned 4%. Your current net worth would be Rs. 67 lakh and your asset allocation would look like this: equities 60%, debt 32%, cash 8%.
Now, your portfolio is no longer the way you planned it. Since the revised asset allocation does not correctly match your risk profile, you are actually taking on higher levels of risk than what you are comfortable with. The volatility of the portfolio will also increase. So, you need to rebalance your portfolio.
Understand the difference between your risk-taking capacity and your willingness to take risks.
What is risk? An appropriate definition of risk is doing something that may be detrimental to your financial health.
Your risk tolerance, on the other hand, is the amount of uncertainty you can tolerate when there is a negative change in your portfolio’s value; in other words, your reaction to negative changes in your investments.
There is a fine difference between risk tolerance and risk taking capacity. Risk tolerance lies in your mind and tells you how much risk you WANT to take whereas risk-taking capacity is the amount of risk you CAN take.
We’re all different and our personal attitude to risk can change with our circumstances and age. The nearer you get to retirement, the more cautious you’re likely to become and you will probably be keen on protecting the fund you