Investing can appear to be a complex process and each individual should ideally approach investing in his or her own way. However, there are a few basic principles one should consider while making investment decisions that can act as guiding beacons. These principles are listed below:
Do your research and start intelligently: As they say, “Well begun is half done”. Research and learn all the various options available for investing your hard earned money so that you are well informed and better-equipped to make logical decisions right for you.
Start investing early: The benefits of compounding can dramatically alter the outcome of any investment. Compounding essentially means interest earning interest, or in other words, your money making more money for you. Here is an example to illustrate the benefits of starting early and investing regular sums of money. Rohan and you start investing Rs 5,000 every month, earning interest at 12% per annum on a yearly compounding basis. The only difference is that you started at the age of 25, while Rohan started investing at the age of 30.
|Age when started investing|
|Years for which they invested|
|Assumed annualized return|
|At age 45, Final Corpus|
Over the time that elapsed since you started investing, you made Rs 25 lakh more than Rohan by investing only Rs 3 lakh more. How did you manage this? You didn’t- Compounding did! Look what a difference those 5 extra years made!
Stay invested for the long term. Stay invested and stick to your plan to continue to benefit from the power of compounding. The longer the time frame, the lower tends to be the overall volatility in an instrument, and the higher the potential to make consistent returns. For example: If you started investing just Rs. 10,000 every month at age 25, by the time you retire at 60, you would have already made almost Rs. 6.5 crore!!! This is because of the power of compounding.
Think of your financial goals: Articulate your financial goals as clearly and honestly as you can, taking inflation into account. Whether you want to buy a 5 seater SUV in 1 year which will cost you Rs 7.4 lakh , or save for your happy retirement in 30 years which will cost you Rs 5.7 crore or simply want to build wealth, remember that the more well thought out your goals, the easier it will be to create a plan to get there. Then create a plan to get there and stay disciplined in order to reach those milestones. Remember that when you think of financial goals, don’t make the mistake of only thinking about your own personal goals. Imagine the next 25-30 years and think of as many eventualities as you can, keeping your family and all its members into account.
Understand your risk profile: Now, before you plan your investments, you need to understand your risk profile.
1) your ability or capacity to take risks , which can be understood by considering various factors such as your current financial status, number of financial dependents, number of working years left etc.
2) Your willingness to take risks, which is dependent on more personal and psychological factors.
3) Your financial goals, which determine how much risk you actually need to take to achieve them.
Understand the risks behind investment products: Consider each investment separately, weighing the risk and return potential of each one as different products leverage different levels of risk to deliver different objectives. The right mix of these products determines the outcomes for which you can plan. For example, in the case of mutual funds, instead of simply looking for the ‘best performing’ product, check the volatility of a considered choice against its investment strategy. Does the volatility match the investment style? If a fund manager claims to run a low risk fund, is this reflected in low volatility? The opposite should also be true; so that if a fund strategy is high risk, you should be able to spot volatility in its past performance. The idea is for you to be able to match your own risk profile and the time horizon of your financial goal with that of the investment products you choose.
Diversify: Ensure that you don’t end up putting all your eggs in one basket. Diversification simply refers to the idea of not investing too much in any one kind of investment and spreading your money over multiple choices, whether in terms of sectors, asset classes or even products. Diversify your investments in order to distribute risk over multiple choices so that even if some of your choices don’t do well for you, the others will provide the balance . This will improve your chances of getting good, consistent returns. For example, if you’re not confident or are just starting out, instead of simply selecting a couple of equity shares to invest in, go for a selection of products such as equity mutual funds, corporate bonds, equity stocks, gold, etc. You could just as well simply invest in a diversified equity mutual fund that matches your investment requirement and has the inbuilt advantage of multiple shares suitably diversified and carefully selected by a professional fund manager.
Allocate assets appropriately: Even if you don’t diversify across products, at least allocate your investments appropriately between different asset classes. You must ensure that you have invested in the correct proportion of high risk and low risk assets to match your financial goals and timing. Remember that equity might do well for some time but debt assets may do much better at other times. The right mix of equity and debt will help you add both growth and stability to your investment portfolio.
To understand this concept better, consider Scenario A wherein you invest Rs 100 in equities only. Consider Scenario B in which you invest Rs 100, but in an equal proportion across different asset classes. Now, assume that the value of your Equity investment falls by 10% and that of your Debt/Fixed income investment increases by 10%., Under Scenario A, the value of your investment would have become Rs 90. However, under scenario B, your value would have remained at Rs 100. This is a simple example of asset allocation in action.
Review your portfolio regularly: You must track how your portfolio is performing at periodic intervals. Do this regularly and rebalance your portfolio if required. If you find that your portfolio has become skewed towards a particular asset class, consider making relevant changes where necessary. or as you reach close to your goals, ensure that you have enough liquidity and low risk investment products in your portfolio; for example, consider selling some of your equity investments and reinvest the proceeds in bonds when you are close to a financial goal.
Seek professional advice: Your investment advisor is a professional expert and can help you to build a proper financial blueprint that takes into account your future financial life. He/She can help you to plan well, stay ahead of inflation and achieve your financial goals by investing in products with a professional structure and a good track record. You must remain disciplined and stay on track. But your dependency on an advisor should not become an excuse for you not to train yourself to become a better investor.
Remember, investing is as much an art as it is a science and with these simple steps, your investing journey could be a lot better.
- While when it comes to investing, there is no one-size-fits-all approach, there are some basic principles that can help you ensure that your investment strategy is working as efficiently as possible.
- Whichever financial goals you are trying to meet, make sure that you retain an active approach to managing your investments. Monitor regularly and take action when required.
- Consider seeking professional advice from an investment advisor or invest in auto-managed products such as mutual funds.