When it comes to investing, not many people seem excited, for the simple reason because investing and finance are very dull, boring and no brainer work which does not require active participation on day to day basis. All you have to do is set aside a small portion of money every month, buy some quality stocks with that money, and hold it forever. It does not require lot of intelligence and hard work to do that, but it’s an important part of our life which cannot be avoided at any cost. Investment is not a choice but a need. There will be a time when you will grow old and won’t be able to work anymore. Investments made today will be the only source of cash flow for you after you retire.
The most common reason given by people for not investing is that they are not able to save enough to invest. That is a myth. It does not take tons of money to create a meaningful corpus for your long term goals. By being disciplined and consistent in your saving and investing habits, you can create a fortune out of nothing. Below is the step by step process of how you can turn small monthly savings (as small as what is lying idle in your kids piggy bank account) into big money.
Money speaks only one language, if you save me today, I will save you tomorrow -Anonymous
In order to invest money, you need to have money first. The only way to have money to invest is by saving more and spending less. Its simple math and common sense, in order to have more money you need to spend less than what you make. Unfortunately, saving is sometimes misunderstood as penny pinching, which is not true. You don’t have to beat yourself up to save. All you have to do is be more logical with your spending habits and prioritize your expenses. Before you go ahead and spend the money, simply ask yourself, is it really necessary? Or can you defer the expense for some later day. By asking this simple question, you put logic of buying above impulsive purchase which can save you from making lot of unnecessary expenses.
If you are still puzzled and cannot figure out how to save money, I would recommend you to read the following books:
A dream does not become a reality by magic, it takes sweat, determination and hard work – Colin Powell
Money grows with compounding effect over time. More time it gets to grow, better will be your chances of getting bigger returns on your investment. Since our retirement age is usually fixed, it is always in our favour to start investing early in our life. Starting to invest early in has two basic advantages.
First, Starting early allows you to take bigger risks with your investment by investing in high risk high return assets. If your investment decisions are in the right direction, you will make huge gains in no time.On the other hand, if you lose money, you have ample time to recover those losses.
Second, since you have started early, you can even start with small sum of money and still reach your goal easily. Those who delay saving and investing have to start with much higher amount to achieve the same result as an early starter. Let me give you an example. There are two people Mr X and Mr. Y both of them get the same amount of salary, and both are going to retire at the age of 60. Mr. X starts saving and investing for his retirement at the age of 30, while Mr Y starts at the age of 40 years.
Both of them start with a lump sum amount of Rs 1,000 and further contribute Rs. 100 every month. assuming the return on investment to be 12% per annum, by the time Mr. X reaches the retirement, his total; investment will turn into Rs. 3,38,057 (Three Lac Thirty Eight Thousand Fifty Seven)
On the other hand Mr. Y who delayed his investment and started at the age of 40, got a return of Rs. 1,01,632 (One Lac One Thousand Six Hundred Thirty Two) If Mr. Y wants to reach the same amount as Mr. X till his retirement, he has to start with a lumpsum amount of Rs. 25,000 (Twenty Five thousand) and invest Rs. 100 every month to his investment. Clearly, starting early makes a huge difference.
Keep Adding To Your Investments:
Financial success requires discipline and consistency – Anonymous
Whether you are investing in a fixed income instrument or in an equity mutual fund, you have it give it some time to grow. As I said earlier, money grows with compounding effect over time, the more time you give it, better will be the returns. Another way to boost your return on investment without much effort is to keep adding some capital to your current investment. When you add more money to your existing investments, your investment base expands and gives you higher returns over long term. You do not have to add large sums regularly, a small sum contributed on a monthly basis will make a huge difference.
To understand it in a better way let us take a simple example. Lets say you received your first salary and decided to invest Rs. 1,000 in an equity fund for your retirement. Assuming the markets average return to be 12% per annum, after 30 years, you will receive an amount of Rs. 29,592. On the other hand if you start with the same amount and contribute Rs. 100 every month to your investment, after 30 years, you will receive an amount of Rs. 3,38,057. Thats more than ten times the money. Clearly, investing small sums regularly to your investment makes a huge difference to your returns. It does not matter how small the sum is, when every penny works for you, the results are going to be awesome.
Be Willing To Take Risk:
Ships are safe in the harbor, but that is not what ships are for – John A Shedd
There is no doubt about the fact that bank deposits are safer than stock market, but that safety comes at a huge cost. Historically, stock markets have been one of the best asset class in terms of return on investment. If we look at the 20 years of history of both the asset classes, compared to 7% annual return provided by the bank deposits, Nifty has provided 12% CAGR return to the investors. Add taxes, and bank deposits, being taxable, are worse compared to returns from stock market that are tax free. You would have to invest more than twice the amount to get the same results from bank deposits as from investing in stock market. Clearly, the risk takes by an investor is sufficiently rewarded by the market in the long term.
“The best way to teach our kids about taxes is by eating 30% of their ice cream” -Bill Murray
There are only two things in life that are certain, first death, and second taxes. There is no way you can avoid death, what you can easily avoid is the taxes eating your profits away. Before investing in a fund or asset class, educate yourself about the tax liabilities it may bring. Ask your financial advisor or Chartered Accountant before making an investment decisions. There are many good schemes that give decent returns on investment and also save your tax liability. By avoiding taxes, you will be able to save lot of money which can be re-invested elsewhere, making your financial journey smoother.
“Do not try predict the rain, work on building the arc” -Warren Buffett
Risk comes from uncertainty, and uncertainty comes from unpredictability. Most analysts dig deeper into a stock or numbers to eliminate uncertainty, which never actually goes away. No matter how much we try, there are always some factors that remain uncertain and pose risk to your investment.
The best way to handle risk is not by trying to eliminate it, but to manage it by spreading the money. Diversifying your investments in various stocks and sectors prevents overexposure of your portfolio, mitigating downside risk. Diversification also allows you to take advantage of growth in different sectors. To understand how diversification mitigates risk and help improving your portfolios performance, let us take an example.
Lets say you invested Rs. 100 in four different sectors, namely, FMCG, infra, technology, and automobile sectors, allocating Rs. 25 in each sector. Now imagine if the infra sector gets into trouble and you lose half of your investment in this sector. The amount that you will lose is Rs. 12.5 instead of the entire amount had you invested only in one stock.Diversifying in different sectors prevented your investments from going down the drain and you still have the skin in the game to recover your losses.
Now imagine another scenario, lets say the FMCG sector outperforms all the other sectors, and gives stellar returns to investors. Had you not diversified your investments, you would have missed the great bull run in this sector depriving you of all the money making opportunities that the sector presented.
Clearly diversification is not just a great risk management strategy, it is also a great way to allocate investment that takes advantage of every money making opportunity market presents.
Track your investment performance:
Setting a financial goal and not tracking it is like driving on a highway with your eyes closed. If you are not on the road, an accident is waiting to happen. Tracking your financial performance against the goals is vital especially for small investors as they do not have enough room to make mistakes.
The best way to track your progress is to find the exact amount you need to achieve the goal and how much you are currently investing. The second step is to calculate the compounded percentage growth you will need to reach that goal. If the percentage of growth is unrealistic or if the risk that needs to be taken is too high for your risk appetite, go back to the drawing board and make necessary changes. After few trial and errors, you will be able to come up with a realistic and working plan. Once you have it, start working on it and keep tracking your performance against the set benchmarks. If the performance is not satisfactory, make a few changes or take some risks if you have to, but do not abandon it just because it does not seem to be working. Slowly but surely, all your efforts and risks taken will finally pay off and you will reach the destination for which you started the journey.
But Before You Begin
Just like you wear a helmet before riding a bike or wear a seatbelt before driving a car to keep yourself safe, before you begin planning and investing, there are few preparations you need to make in order to ensure your safety, and of your dependents. Here are the preparations you need before you begin:
Make an emergency fund:
Life is full of uncertainties, that is why it is always better to be prepared for the unforeseen events. Create an emergency fund which is equal to your annual income. In case you lose your job or face a medical emergency, this fund will prove to be really helpful. Always keep it in a highly liquid asset (any financial instrument that can be quickly converted to cash.) so that it is easy to withdraw in case of emergency.
Buy a term Insurance:
In case anything happens to you, your dependents will be safe and would be able to live their life after you.
Pay off high interest debt:
Debt is like a whole in the ship, it may look insignificant, but can sink even the biggest ships. So instead of throwing the water out of the boat (that is paying interest), better work on fixing the leak. Its much better and easier solution.
The whole idea behind writing this blog is to encourage young and small investors who have just started their career and do not have much savings to invest. There is a popular belief that financial planning can be done only once you have a meaningful amount to invest. This is a myth. You can begin even as a student and still reach the goal you desire to achieve. My purpose of writing this blog post is to give such investors a working strategy, which they can use to plan their future and achieve financial goals. Hope I was helpful to you in this purpose.