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Why should one plan one’s Investment?
While the answer is obvious, to be lucid, one needs to plan one’s Investment primarily due to two reasons:
• One needs to build up certain reserves for meeting any future bulk expenditure that arises because of an unforeseen event in the future - the expenses of which cannot be met by one’s salary income alone.

• Any growth in economy is accompanied with inflation. Future income requirements are always more than the past due to depreciation in the value of money. Moreover, in the current scenario, no one can be assured of regular income throughout their career span, and it is always best to grow one’s nest egg to meet any future needs. One needs a nest egg to provide security in case there is disruption in one’s regular income, one needs to meet monetary requirements post-retirement and also, as the family expands, future needs also grow with addition to the members of one’s family.

Tip:Time is the best friend of a long term investor and compounding, the most important tool. The earlier one starts investing the higher the impact of compounding. (See the glaring results of starting early in our earlier article 'It wasn’t raining when Noah build the Ark!')

Is it better to invest periodically or in a lump sum?
One of the questions that people often ask is how should you invest – is it better to accumulate and invest in a lumpsum, or invest periodically.

Let us examine both possibilities. When we evaluate them, we find that the best approach here is to be regular throughout one’s productive period, (Productive Period = the period when one earns regularly on a Monthly basis), rather than accumulate and invest periodically. Why? Because the latter method ends up in loss of income due to opportunity loss of earning return on idle funds.

Hey I have a regular salary and housing loans are easily available. Should I look at buying a house? Is it a good idea?
Commonly it is held that the most logical investment one would like to look at is buying one’s own house. But, before one gets into doing that, which is, usually, a one time major investment, it is better to weigh the pros and cons:
• It is advisable to take a housing loan and invest in a house, only if one is sure that the place of work will remain in the same city where one purchases a house for at least the next several years. In that case one would substitute payments towards rent with payments towards EMI. There are also some tax concessions on housing loans which one can then be entitled to. However, please do not look at buying a house as an Investment. You will be putting too many eggs in one asset, that too one which is not very liquid.

• In case one purchases a house and gives the same on rent, one loses return on his investment, as rents typically yield a very low return (even in a city as costly as Mumbai). Also, one increases the risk of letting out as the tenant may not move out on a timely fashion, when one needs the house again for self use; and if things get worse; one could spend a lot of unproductive time in legal battles.

• Due to the above reasons, we do not believe it is advisable to look into buying a second home as an investment, and that too, with money borrowed from Banks, as, in such cases, you may end up working for the Bank to earn a regular interest income at your cost and efforts.

Tip:Please do not look at buying a house primarily as an Investment, but only, if you want to use it for self.

If I do not go for a buying a house immediately, what other important decisions do I need to make?
In that case have you thought through your insurance plan?

The first question to ask then is, have I taken care of for exigencies? Exigencies are situations one cannot predict. Ask yourself - Have I looked at a scenario, how the Family would be protected, if something were to happen to me? If I am a bread-winner of the family, in case of my demise will there be immense financial pressure on the family members left behind?

Please note in case the answer to the above question is yes, then you need life insurance. However, in case there is no likelihood of significant financial pressure on the family in case of your demise for whatever reason, then you may not need insurance. Please note every product has a cost, including insurance.

• In case of taking life insurance, it is advisable to insure oneself right at the beginning of one’s career as premiums are lower and one is normally healthier then. There are many organizations which provide some sort of insurance covering medical and accidents. Despite the other insurance covers, one needs to cover oneself with a Life Insurance product. Here, there are many options available, but it is best to avoid getting into discussions with many Insurance agents, and come out more confused. Please note that the Insurance agent is normally working more for himself, than for you, and as such would advise you such products where he earns maximum commission; which in many cases would be sub optimal for you.

• So what do you do? Please do not confuse insurance with investment. Go to insurance companies for life insurance and to other financial institutions for investment. It is best to choose a pure Term product (as opposed to any form of Unit Linked Insurance Products or Money Back Products) which covers Life.

• Pure Term policies are the cheapest in terms of premium to be paid as it can be claimed only if there is a loss of Life and there is no promise of a return of the Premium at any point in time in future. But that is fine, as one is looking at Insurance only for the purpose it is taken and not for getting a Return, as return from Insurance always tend to be lower than most of the other avenues of Investments. Please remember it is important to be optimally insured, and neither under nor over insured. Also we suggest you read our earlier article on the issue - 'Life Insurance - Not Life Investments'.

• All earning family members can consider taking Insurance, as it is meant for a payment to be received if the Earning stops due to unforeseeable circumstances, in this case, loss of life.

Tip:Choose a pure Term product (as opposed to Money Back Products); Pure Term policies are the cheapest in terms of Premium to be paid.

Now lets look at investment options
Investment options in financial instruments can be basically divided into two groups. The first group consists of interest-generating instruments, or debt instruments and the other consists of equity alternatives. An interest generating investment is a loan that provides a return in the form of interest payments, with the promise that the principal will be returned at a stated maturity date.

The primary advantage of this kind of investment is that the cash flows are specified in advance. The major disadvantage is that these investments tend to be very susceptible to inflation. By comparison, equity investments are equity ownership interests in businesses. An equity investment provides a return in the form of dividends and/or capital appreciation. The primary advantage of an equity investment is the prospect for real (i,e., inflation-adjusted), long-term capital growth. The major disadvantage of an equity investment is the high short-term volatility of principal value.

The right combination of these group of investments is determined by the time horizon of the investment (the longer the time horizon, the greater the advantage equity investments normally have over debt investments), the risk appetite of the investor, the need for diversification and specific investment objectives and goals.

Let’s discuss some specific investment instruments and other investment considerations
Provident Fund: A good avenue for Investment is, to use those products which capture the Power of Compounding, and also provides extra Tax Shield.

Most employers extend the facility of Provident fund to their Employees. In this case, the Employer contributes, say 12% of the basic pay of the Employee and the Employee has to provide a matching contribution every month; the entire amount is usually tax free and earns an annual interest (current rate is 8% per annum). There is maximum cap of the extent to which it is Tax free and it is currently limited to Rs 1,00,000 per annum (under Sec 80C of the Income tax Act).

What happens if the employer does not provide PF facilities?
In case the Employer does not provide PF facilities, then one can look at investing in Public Provident Fund ( although one can consider investment, even if the Employer extends Provident Fund). The max. investment in PPF is limited to Rs 70,000 per year and earns an Interest of 8% per annum. It also provides tax shield, but the overall tax-shield ceiling is limited to Rs 1,00,000 (PPF clubbed with other investments which have Tax set offs) under Sec 80C of the IT Act.

While PF can be carried forward throughout one’s career and transferred from one employer to another, when one changes his job, PPF is for an initial period of 15 years and can be extended for blocks of 5 years after that. There is a limited facility of withdrawal after 6 years, but it is best not to withdraw and rather keep the amount for at least 15 years; as this provides a hassle free neat corpus at the end of 15 years. The beauty of this investment is that it cannot be attached by any outside party (principal as well as interest) and as such provides for such exigencies, if one were to lose all his wealth due to some reason or other.

Tip:Look at investing in Public Provident Fund, limited to Rs 70,000 per year and earning an Interest of 8% per annum for at least 15 years, and providing tax benefits.

Yes, I have taken Life Insurance Policy, and also made PF/ PPF Investments, what next?
I still am generating surplus after the above investments, what do I do with it? Now one needs to look at other avenues of Investments, primarily focused on meeting one’s various requirements; basically, these investments should be made keeping in mind, when do I require a sizeable sum of money to be available at my disposal? Everyone has short term needs as well as medium to Long Term Needs. Hence, it is wise to Plan One’s Investments considering these requirements.

Very short term requirements: It is advisable to keep at least one to two months of Savings in a Liquid form to meet any immediate expenditure. Typically such amount is kept in a savings deposit account with a Bank. As a savings deposit gives the lowest return ( 3% per annum on a min balance between 10th and last day of every month), it is better to keep this amount in a savings linked Fixed deposit with a bank.

• Short term requirements: Short term investments are those investments one is not likely to touch for a period of one year. One can plan short term investments in a debt instrument. Broadly a debt instrument can be classified as one in which the Principal earns an Interest for a pre determined period of Investment and one can expect to get the Principal back, with a high level of safety along with the Interest earned for that period.

• The most common form of investment for a one year debt instrument is a bank Deposit (Term Deposits or recurring deposits); however, the return one can expect is also low, typically it varies from 5 to 6% to around 8-9%, based on market conditions. In a very liquid market the deposit rates come down and in a tight market, the rates are higher. Please note that any interest earned more than Rs 10,000 per year will attract a tax deduction at source from the bank (around 11-12% tax plus surcharge is deducted by the Bank). One can expect to earn slightly higher interest rate with a NBFC deposit or with a Company deposit, but like any investments, these come with a higher degree of risk.

• As a common investor may not understand how safe it is to invest in an NBFC or a Company, it is best to keep this amount in the safest form, i.e in a Bank Deposit and that too, in Nationalized banks. If you need to earn a little higher interest rate, but take a higher risk, it is best to consult your Financial Advisor, who would be able to predict reasonably well about the safety of your investment.

Medium Term Requirements: Under this category will fall all those investments, which can be safely kept invested for a 2 to 3 year period. One can look at both Debt and Equity as forms of Investment under this category. Under Debt, once again the investment can be in Deposits or in Bonds/ Debentures of companies. Under Deposits, once again it is Bank Deposits, or deposits offered by NBFCs as well as Corporates. The rates of deposits offered are lowest from banks and relatively higher for NBFCs and Companies but deposits from NBFC s and companies carry a higher level of Risk. In case the company stops generating cash flows, they will find it difficult to service the Deposit holders. Moreover, the company may not pay interest for the period of delay and that is a loss of return for the investors for that time period.

• It is advisable to keep deposits in the safest form of investments: Nationalized bank Deposits or Deposits from Quasi Govt bodies / PSUs like EXIM Bank, NABARD, SIDBI or highly rated Institutions like HDFC, etc.

• As far as equity investments are concerned, this will require expertise and it is best to consult a Financial Advisor for such investments. Equity investments are the most complex as it is not only important to choose a good company to invest in but it is also important as regards to timing of one’s investments and price at which one purchases the shares; same company may be available at a very high price or at a very reasonable price. As the investment is for a medium term of 2 to 3 years, it is extremely important that one buys the equity of a company at a price where there is scope for reasonable appreciation in this time period.

Long Term Investments: We classify any investments as long term, if they are kept invested for at least a 3 year period or more. In a long time frame, equity always provides a much higher return than any form of Debt investments Hence it is advisable to invest mainly in Equity for Long Term. While it is easy to decide on this, the complexity arises from choosing one’s investment; just like in a medium term scenario, timing and the quality of investments become very important for these. It is best to take the help of a Financial Advisor for such investments.

Some important things you should know
Cost of Investments: It is also extremely important to get an idea of the typical costs involved in any investments. Typically an investment in a Bank Deposit will not involve any cost, for entry. In the same way, if one keeps the deposit till maturity, there would be no cost involved. However, if one needs the fund earlier than planned, and wants to break the deposit, then there is a cost involved, as the Bank will return the principal at a lower Deposit rate (based on the period after which the deposit is broken / some banks even penalize the depositors, by reducing the deposit rate by an additional penalty rate ).

For a Debenture or a Bond, there is no cost for Primary investments; i.e the investor invests at the time of Initial issue by the issuer; however, if the debenture is bought from the Market (wholesale segment of NSE), the investor will need to pay the brokerage to the Broker who carried out this transaction; in the same way, if the investor sells the debenture before maturity, it can be again carried out through the exchange, and here again the brokerage which is to be paid.
However, if one holds till maturity, no brokerage needs to be paid; some debentures carry a Call and a Put option: that is the right of the issuer to call the debentures before the Final Maturity, and in the same way, the right of the investor to put the debenture at a set date prior to the Final Maturity; here again, there are no transaction costs involved.

For equity Investments, once again, there is no cost for subscribing to an initial Public offer (IPOs) or for Rights Issues. However, most of the equity investments are carried out in the secondary markets, and are done through a stock broker. Here one needs to pay brokerage charges, which vary from broker to broker. One needs to pay brokerage both at the time of buying as well as at the time of selling the equity shares. Additionally, the shares are held in custody by a Custodian in a Dematerialised form and there are Demat as well as custody charges which need to be paid on a periodical basis.

What is a Mutual Fund? Can I invest in a Mutual Fund?
A Mutual Fund is a facility extended in our Capital Market, by which funds are pooled from both Retail and Institutional investors who are allotted units by the asset management companies which runs the Mutual Fund. These AMCs are manned by professionally qualified people who manage the investments on behalf of the individual investor.

Typically a qualified professional is appointed as a Fund Manager who carries out investments as a full time job. He invests the corpus in various companies, both in debt and equity. The Fund can be a pure Debt Fund or a Pure equity Fund or a Balanced Fund, which is a combination of Debt and equity.

What are the cost of investments through a Mutual Fund?
The mutual fund usually charges an entry and/or an exit load for each scheme, along with a management fee. One can enter into a particular scheme based on one’s preference for investment. Typically the costs through a mutual fund are higher as compared to a direct investment in stocks, as the mutual fund uses this cost to meet its expenditure on remuneration to professionals, office expenses as well as payment to distributors who bring the funds from Investors to the mutual fund. A cheaper alternative to investment through regular mutual funds is to invest in passively managed funds like index-funds.

How does one choose a Mutual Fund?
This is a very complex decision and is best left to your Financial Advisor. It is very important not only to know the past track record of the particular scheme, but also the Fund manager overseeing the investments and his Track record in the past. Even if everything is favourable, there is no guarantee that your investments are protected and will earn a reasonable return.

Typically, a Mutual fund earns its return in line with the Equity Capital Market; if the market starts moving upwards, one can expect positive returns from the mutual funds. A good Fund Manager should be able to fetch you a return better than if you were to directly invest in the Market; however, as many Fund mangers do not continue long with a single AMC, it is important to look at the longevity of the Fund Manager in a particular AMC, before choosing that AMC. Alternatively it is better to invest with Mutual Funds with a long track record of performance across funds, so that the exit of a fund manager will not drastically affect returns.

In case of Debt Investments, there is a different complexity. As the Price of a Government Bond or a Company Debenture moves up when the interest rate of the economy move down, the NAV of a Debt Mutual Fund moves up in a declining interest rate scenario; hence a Debt Mutual Fund can be looked into for investment, in a sliding interest rate scenario. Again, since predicting the direction of interest rates is difficult for a common investor, it is best to consult a Financial Advisor / Planner for such investments.

You have referred to a Financial Advisor / Planner Several times in your Article, please advise us, how do I select a good Financial Advisor?

Before knowing this, one should be aware of who are NOT good Financial Advisors / planners. In fact, in the Indian context we mainly have financial advisors who are agents / brokers for the financial products that they are advising one to buy.

They earn their income primarily from the brokerage/ agency commission they receive from Financial Institutions. In such cases there is normally a conflict of interest as the agent will try and sell products which earn him/her a good commission and this may be different from the products which are best suited to the needs of the people they are advising.

As this is an important issue, we will be happy to dwell at length about who is a good financial planner/ advisor in a sequential article to the above piece.

Mail us at wealthdesk@6bridges.com if you wish to ask more about financial advice.