Everybody wants to learn how to pick good investments. However, very few make preparations before investing. Just like you need to have all the ingredients listed out and on hand before making a dish, you need to follow certain steps if you want to get the best out of your investments. These steps are more important than choosing great investments.
- Determine your goals and how much it will cost you to achieve those goals
Before investing always have a goal, like funding your child’s education, building a house or your retirement. Decide how much money you will need to meet that goal.
It is easy to determine how much money you will need to build your house or fund your child’s education. But, it is difficult to determine the money you will require after you retire. Here’s some help. First, decide on what lifestyle you plan to lead. Simple? Extravagant? Somewhere in the middle? Then think of the expenses that you might incur. The main ones will be housing costs (rentals, repairs etc.), medical expenses and entertainment expenses (concerts, theatres, religious places – that’s not exactly entertainment, but you know what we mean). Others may be transportation costs, pilgrimage expenses, gifts for the grandchildren and so on.
After determining the money you would require, estimate the number of years you have till you will need the money. Don’t forget to take inflation into account!
Determining your goals will help bring discipline to your investing. Estimating the number of years you will be funding the goal will help you decide on your investment style. The more the number of years to your goal, the more aggressive you can be with your investments (read equities!). As you get closer to the goal you should become conservative (read Fixed Deposits). This will help you protect your gains.
- Determine your asset allocation
The most important step before investing is deciding your asset allocation. Your asset allocation is your portfolio’s mix of shares, bonds, and cash. Equities are obviously riskier than bonds/cash. So, just like some may want more cheese or more sauce for their pizza, others might like more equities or more bonds in their portfolio. Finding the best asset mix is crucial if you want to meet your goals. Your asset allocation depends on the following:
- Number of years to your goal
- Money needed for the goal
- How much can you invest now?
- How much can you invest each month?
- And the most important – how much risk can you take?
If your risk tolerance is low, you should allocate more funds to fixed income securities, that is, bond funds. If you have a high risk tolerance level, you can invest more in equities, that is, equity funds. The higher your tolerance, the higher should be your allocation to equities.
If you have only a few years to meet your goal, invest more in bond funds. If you have many years to achieve your goal, invest more in equity funds. The longer the time, the bigger the allocation to equities.
- Would you prefer a lump sum or SIP?
Systematic Investment Plans (SIP) are very popular and allow you to invest small sums over at regular intervals over a period of time. They keep averaging out the cost of owning your Mutual Funds. But, if you are thinking about investing lump sums such as your yearly bonus, you can do that too. Ideally you should be investing through both routes.
- What if you need money before you reach your goal?
Do not invest all your money. Always have some money on hand in case of an emergency. This will ensure that you do not have to sell your investments before you reach your goal. The best place to keep your emergency fund is in your savings account or your deposit account having a sweep-in, sweep-out facility. You could also consider liquid funds for keeping your emergency funds if you want to earn interest that is a bit higher than your savings account.
Investments require you to stay committed in the long run if you want to get the best out of them. Mutual funds are no different. Loans need to be closed quickly while investments need to be nurtured for a long time. This is the best rule to follow to remain financially healthy.