Almost all of us, at some point of time start working and earning money. Most of us continue doing it till the age of our retirement and may be after that. A proper planning of the earned money will make us financially secure. Most of us do not have much knowledge about investment and managing money at the start of the career. As a result, we continue spending the money in our own ways and after some time, we start feeling short of cash whenever we need it.
It is only after a few years, we realize the importance of the savings and start saving the money. But at that time, it becomes very difficult to do so. It is because at that time our spending habits become difficult to control and also we have some new type of expenditures coming up. Further, the earlier you start, the lesser money is needed as regular investment to generate the same final amount at the end of the investment cycle. This is because of the magic of compounding. To understand it, we have to learn about a few of the very basic rules.
Rule of 72
For any rate of interest, say x % per year, your money doubles approximately in 72/x years. For example, at a rate of 9 % per year, your money will double in about 8 years. Similarly, at a rate of 12%, it will double in just about 6 years.
Magic of compunding
Compound interest may look simple, but it may do wonders in long term. It will help your money multiply very quickly. Say, for example, if your interest rate is 9 %, then your money doubles in 8 years. It becomes 4 times in 16 years and further 8 times in about 24 years. That is, the more time and the interest rate you have, the more gains you can make. You can also note that the sooner you start saving the money, the lesser amount of money you need to save regularly to reach the amount at the end of a particular year.
For example, at an interest rate of 9% per year, if you invest Rs 10,000 monthly now, after 8 years you will get about 14 lakhs rupees. If you want to reach the same amount, but would have started 8 years before, you would have needed just about 3500 rupees per month. So, the sooner you start, the lesser amount you need to save and more gains you can make.
Time value of money
The invested amount which gets doubled in a few years does not mean it’s value has actually got doubled. The value of your money actually depreciates with time and it depends on the ongoing inflation rate. Higher the inflation, the lesser its value will be. That means, if you keep your money idle, then at one point of time its value will become almost zero. Using the law of 72, you can find the future value easily depending on the inflation rate. For example, if the average inflation rate is about 6 percent, the value of your money will be halved in about 72/6, that is 12 years.
That means, while planning your investment, you also have to take care of the inflation. You should try to invest in such a manner, that the return is higher than the inflation rate, or else, your money value will actually decrease over a period of time. Another, thing you have to keep in mind, that inflation can be negative too, which will result in increase of the value of your money in future. But, it is a rare phenomenon in developing economies like India.
Assets & Liability
In simple terms, Asset is something which is able to generate income while liability is something which takes away a part of your income. In other words, assets increase your income which can be used to create more assets. Liability, on the other hand, decreases your savings and negatively affects your potential to create more assets. Your goal should be to create more and more assets and keep your liabilities to the minimum.
Returns of various investment methods per year (Approx) with 6% inflation
Different investment methods have different returns. Usually, more the return, higher is the risk involved. There are some more investment methods available like direct equity,real estate etc. which is not discussed here as this post is written from a beginner’s perspective. A beginner in investment may not have that large amount of capital to invest in those investment methods. A comparison of the different investment types can be seen in the table below.
|Investment type||Approx. Return||Return adjusted with inflation @ 6%|
|Keeping cash at home||0%||-6%|
|Debt Mutual funds||6%-12% (average)||0%-6%|
|Equity mutual funds||10%-20% (average)||4%-14%|
|Stocks||30% or more (unpredictable)||24% or more|
Making your Investment Plan
As you can see from the table above, Different methods of investment have different rates of return. Normally, anyone would be tempted to choose the method providing the highest rate of return. But, it would be actually a very stupid decision to make. This is because, each of these investment methods have different magnitude of risks involved. Government backed schemes like PPF,KVP etc. may be providing less returns but they are usually risk free. Your fixed deposits are also very safe unless the bank collapses.Mutual funds may have moderate to high risks. Gold price may also come down at some point of time if the demand gets low. If the company is not doing well, then its stock value may become very less, making you lose most of your invested money.
So, the goal of your investment should be also to keep the risks involved within the limits along with maximizing your returns. Your risk taking ability may be different at the different phases of your career. For example, at the start of your career your savings would be very less and therefore you cannot take big risks. After few years, when you have saved some money, then you can take bigger risks and also get better returns as a result.
How to start your investment
When you start your job, try to save as much money as possible. Your focus should be creating a few assets as soon as possible. These assets will increase your income and enable you to create more assets. Try to keep your liabilities to the minimum. If you are thinking of buying any liabilities like a car, try to delay the decision as long as possible and manage your life with your existing resources. If it is necessary to buy a car, try to buy as cheap as possible so that your expenses would be minimum.
Auto Sweep account
To start with, One thing you can do is to convert your existing salary/saving account into an auto sweep account. This facility is available with all the major banks. What it does is that every month on a specified date, above a certain threshold as specified by you, it moves the excess idle money to a fixed deposit account on which you earn a higher amount of interest, usually about 1.5 times than what you were getting with your saving account. This excess money will remain in your account only and you can withdraw this excess money as per your needs as you would have done if it was in your saving account, with the added benefit of getting a higher interest.
Create Emergency Fund
Next, you can try to create an emergency fund. An emergency fund is a fund created to cater to your needs in case some disaster happens like loss of your job, critical medical care expenses etc. Generally, you should aim to keep about six months of your expenses as emergency fund. You can try to save as much money as you can per month from your income and finish creating this emergency fund as soon as possible.
After creating your emergency fund, your next objective should be to take a life and a medical insurance. Ideally, you should not wait for the creation of the emergency fund to take these and you should do it as soon as possible, even while you are in the process of creating your emergency fund. However, it is suggested that you wait for few months after getting your job so that everything settles down. Once you are settled, you can study your expenses and requirements easily and analyze your insurance needs.
If you are working for some company, there is a very good chance that your medical insurance is already taken care of. Sometimes, life insurance is also taken care of by the companies but it is usually of very small amount which may be inadequate for you. So, you have to take a medical insurance if you don’t have and a life insurance.
You can choose and buy both the types of insurances very easily online. Select any one medical insurance as per your needs and buy it directly from the company website through the online mode. It comes much cheaper as compared to buying from agents. Do not try to get unnecessary and costly addons with your plans and buy only what you would be actually needing. Similarly, you can also buy a life insurance for yourself directly via online mode.
You have to be a bit careful in choosing a life insurance plan. Almost all companies sell two types of insurance plans. The first is pure insurance (term insurance), where you deposit a fixed sum/premium monthly/yearly and your nominee get paid an assured sum in event of your death. You won’t get the money back in case you survive.This type of insurance is sold very cheaply.
The second type is a bit costly and is insurance added with investment. In this type, you deposit a fixed amount/premium monthly/yearly and your nominee get a minimum assured amount in case of your death. If you survive, you get the amount deposited with some interest/bonus. The interest/bonus comes out to be so low that the whole insurance package becomes too costly with very little value. So, always get the term/pure insurance plan and never go for the second type of plan with investment. Also, do keep in mind that the premium of the term insurance increases with your age. So, it is better to buy the term insurance as soon as possible.
Plan your retirement
Once you have the emergency fund and insurance, you have minimized your risks to a great extent. However, You also have to secure your life after retirement. An easy way to do that will be subscribing to a Pension/retirement scheme like Employee provident fund, National Pension system etc. Your company may have already subscribed you to one of these. If not, subscribe to any one of these and start saving some money regularly per month for your retirement.
Save money safely and taxes too
Now, you have all the basic things set up and your risks are reduced to the minimum. You can now accelerate and look out for high return yielding investment methods, slowly but steadily. You can start with government backed schemes like PPF,NSC, Sukanya Samriddhi Yojna etc . Not only they are very safe, but most of them can also help you save your taxes. Try to use your tax saving potential to the maximum by investing to the full limit of Section 80C.
You don’t need to put your money in these schemes all at once, but you can invest regularly in monthly or quarterly installment too. In fact, this is the preferred method as it helps in developing the habit of saving money. Do not put too much money in these schemes. Put only or little over the amount required under Section 80C to save the taxes. Too much investment in these schemes will leave you with little cash to invest in other high return schemes.
Investment in Gold
At this point of time, you may also look forward to invest some of your money in Gold. You may already be having some Gold with you. If you like, you can put some money in Sovereign Gold bonds which is a safer bet. This is optional for you because at some point of time you will be having gold anyhow due to the need for jewellery etc. but still some investment in Gold is recommended.
Investment in Equity
After completing all the above things, you can now start exploring some of the high return investment methods like equity. A simple method to do it is via mutual funds.Mutual funds are of many types based on the instruments in which they invest. To keep things simple, Let us bother only about two types, debt and equity mutual funds. Debt mutual funds are investing in debt instruments and they are a bit safer as compared to the equity mutual funds. The equity mutual funds invest their money in stocks of the companies and may be volatile. Depending on your savings, you can start a fixed amount of investment per month (also known as Systematic Investment Plan or SIP) in the mutual funds.
You can start with 4 or 5 star rated mutual funds. Also make sure to always buy the mutual funds directly from the asset management company online through their website/app and opt for direct plans. The companies also sell regular plans through their agents which will cost you their commission of about 1 % per investment. This becomes a large amount to lose in the long run due to compounding. Also never chose the dividend plans. Always go for the “Direct Growth” plans while choosing any mutual fund.
Equity mutual funds, though volatile in nature, perform very well if you are planning to invest for a long duration, say more than 3-5 years. If you are planning to invest for a shorter duration of less than 3-5 years, you should go for debt mutual funds. Since, you have just started your career and have already minimized the risks by taking steps above, it makes more sense to invest in equity mutual funds rather than debt mutual funds. Still, if you want to play safe, you can invest a small portion of your money in debt mutual funds too. You can select a 5 star or 4 star rated short term or medium term debt mutual fund for this or a combination of both. Long term debt mutual fund can be ignored at this stage as equity mutual fund will do better in long term.
You can invest the remaining money left after investment in debt mutual fund into equity mutual fund. Equity mutual funds are mainly three types.
- Large cap funds which mainly invest in large sized companies. Investment in these funds are comparatively safer and less volatile than other equity mutual funds. You should plan to remain invested in these funds for at least 3-5 years.
- Mid cap funds which mainly invest in mid sized companies. Investment in these funds are a bit riskier and more volatile than large cap equity mutual funds. You should plan to remain invested in these funds for at least 5-7 years. Their return potential is higher than the large cap funds.
- Small cap funds which mainly invest in mid sized companies. Investment in these funds are a bit riskier and more volatile than mid cap equity mutual funds. You should plan to remain invested in these funds for at least 7-10 years. Their return potential is higher than the mid cap funds.
Rather than investing in lump sum, you should invest money in mutual funds regularly, say monthly or quarterly. You should also scatter your money across the mutual funds types to minimize your risks. An example is shown below considering you have a saving of Rs 20,000 per month left to invest. You are free to modify it as per your needs. Also, keep in mind that some available mutual fund also act as mixed/hybrid funds. They may be a mixture of two or more fund types.
|Mutual fund type||Percentage of Investment ( Amount out of Rs 20,000)|
|Large cap Equity fund||40 % (Rs 8,000)|
|Mid cap Equity||30 % (Rs 6,000)|
|Small cap Equity||20 % (Rs 4,000)|
|Debt fund||10 % (Rs 2,000)|
You should continue investing in mutual funds.You should also set some goals related to your mutual funds. Say, you plan to buy a car after 5 years which you can link with your large cap fund investment. After 5 years, you can withdraw your money from the large cap fund and get a car. You should do this, because mutual fund even though look safe, but still carry some amount of risk as they are based on the market. The goals will keep you motivated. It will also let you use your money at different intervals. As a result, you will be less susceptible to market movements.
Should you invest directly in stocks?
You might me thinking about buying stocks directly now. But do keep in mind that stocks are very risky and volatile. Before investing, you should have good knowledge about analyzing good and bad companies. This takes some time for learning, experience and research. As a beginner, you should stay away from stocks and keep learning about it for some time until you are confident to start investing. Start investing only in small amounts and increase slowly as you gain experience. Do not be greedy or speculative and always plan to hold stocks of good companies for longer duration. If you are doubtful, better ignore the stocks completely and focus on your investment in the mutual funds.
Optimizing your Investment
Now, that you have invested all your savings properly, its time to optimize it. You should review your portfolio/investment plan at least every three years.Try to keep your portfolio balanced. For example, for tax saving under section 80C, you may be doing investments in PPF/fixed deposits. Once you have accumulated some good money in PPF/fixed deposits, you may reduce your investment in PPF/FD. You can then look for tax saving schemes with higher returns than PPF/FD even with a bit of risk. Equity linked Saving savings scheme (ELSS) is one such scheme. Under this scheme, you can invest some amount regularly in ELSS mutual funds. These funds offer better returns and comes with a lock in of just 3 years as compared to 5 years of FD and 15 years of PPF. Similarly, you can change the distribution of your investment in mutual funds as per your new goals.
If you plan your investment well, you will be able to manage your money properly. It will prevent it from getting wasted either by sitting idle or through unnecessary expenses. Your investment will also be yielding some amount at frequent intervals. This will also help you in maintaining a good positive cash flow easily. This extra money coming out can be utilized to create more assets or for spending in other activities. You should also try to increase your investment amount regularly as your salary increases. This will help you to fight the inflation eating up your investments.
Hope this guide helps you to start your investment journey smartly.
Disclaimer:- The above guide is not a professional advice. It is only based on own experience and knowledge gained from various sources. It should be noted that various investment avenues like mutual funds are subject to market risks. Though efforts are made to reduce the risks to the minimum in this guide, the reader should also be careful himself and read all necessary related documents prior to investing in a particular avenue.