Wednesday, October 6, 2010

Part 19: Investment is not Rocket Science

Now that you have patiently read through eighteen parts, it might have dawned on you that this whole subject is actually very simple. It talks of common sense strategies based on assumptions that you seem to be able to follow. Well, investment is not Rocket Science – you just need to keep in mind a few simple things to navigate the world of personal finance!

Simple things like what? It does no harm to reiterate and summarize once in a while. If I were paid by the word, I would do it more often – but in any case I think the time has come to collect our thoughts and summarize our strategies.

How much do you need to retire? For this, you have to answer the question: What is the lifestyle you wish to lead? Estimate your current monthly expenses. Multiply that number by 500. That is your target. Of the monthly income that you will get from this amount, spend half and save half – the saved half will take care of inflation. This presumes you already have a house the loan on which is paid for.

Don’t bother trying to put a spreadsheet spanning the next fifty years; estimating how many children you will have; when they will get married; what diseases you will have in your old age and how much your medicine will cost then; what you will spend on your son’s education, etc. If you do all this and work it backwards, and then reach a conclusion that you will need to save twice of what you earn today, then what will you do? Avoid useless intellectual speculation – in any case you cannot see five years ahead, forget fifty – just start from where you are.

Estimate how much you will need to spend every month – and let this number be significantly less than your income. Pray that the number stays significantly less than your income. Divert the rest into a separate bank account by “Paying Yourself First” – once the money goes there, it is to be used only for investments. As your income increases, do not increase your spending in proportion. As you grow older, your savings as a percentage of your total income should rise. If your spouse is earning, then over and above this, one salary should be fully saved. As you progress, your investments will start yielding interest or rent; this income should be automatically saved too. The idea is to progress in such a way that passive income keeps on rising; and the proportion of active income, where you have to slog to earn, keeps on reducing. And one day you will no longer need to work. You may choose to, but you should not need to.

The money that is kept aside for investment cannot be kept idle. It needs to be invested so that it grows. There are not too many options for this. The investment options are actually few.

Keep aside a few months’ expenses in your savings account or in Fixed Deposits that can easily be liquidated. These are your emergency funds. Now explore tax saving avenues. Estimate what is the maximum amount you can invest after deducting your PF, insurance premium, children’s school fees, etc. from the one lakh limit for 80C. Invest this amount in PPF, ELSS, or five-year term deposits that allow for tax exemption. Invest up to Rs.20,000 in Infrastructure Bonds - this is over and above the one lakh limit.

Spend on a pure term insurance policy. The amount of coverage should at the very least be twice your annual income after covering all your loans. Ideally, you can even take coverage up to seven to eight times your annual income, but there will come a point when you will balk at paying the premium. Just insure as much as you can or are comfortable, keeping a minimum of liabilities plus twice annual income in mind. Do not look at any other kind of policy – no ULIP, no money back, no endowment, no whole-life, no nothing. As a general rule, go with the company that offers you the lowest premium.

Choose one or two large Diversified Income Funds and one or two large Diversified Equity Funds from among the top fund houses. There are several magazines and websites that rate funds – you may consult them if you wish before choosing; just remember, past performance is no guarantee for the future, and so long as you choose one or two funds each of Debt and Equity,  you should do fine.  Do not look at any “specialty” funds, or sector funds, or any other kind of funds. You may if you wish add one ETF based on the Nifty Index if you wish to, as part of your fund portfolio. 

Invest part of your money in the debt funds and part in the equity funds. Do not worry too much about the state of the market, etc. Unless you are thoroughly convinced that the market is overvalued, in which case, decrease your equity allocation slightly, or shift some money from equity to debt; if you are convinced that the market is highly undervalued, you would do the reverse – but these calls should be an exception rather than the rule. By and large you should invest a steady amount in equity, and a steady amount in debt, without worrying too much about market movements. Do not make the mistake of investing small amounts in multiple funds under the excuse of diversification – each fund is diversified already – it only increases your work and doesn’t make sense. 

If you have small scattered amounts invested in various funds, consider consolidating them into one or two funds at most. If you are interested in investing directly in equity, then you can do that instead of investing in the equity funds. This column does not venture to offer advice on how you should go about investing in equity directly – that is another big world out there that you can go out and explore if you wish.  If you are directly into equities and you do make lots of money, I would like to hear from you and pick up a few tips!

Invest some part – anywhere between ten and twenty percent – in Gold. There are only two permissible forms of investment in Gold – gold biscuits, and Gold ETF’s. Of the two, I prefer biscuits. You should too, unless your investment is for the short term, in which case you can consider ETF’s. Ornaments are for ornamentation, they are not investment. Do not buy gold biscuits from a bank. Always buy them from a jeweler. Silver is also a good idea – in fact, I think it has more prospects than gold in the long term – and you could look at investing in silver bars. Storage is bit of an issue though; there are no Silver ETF’s in the Indian market.

And then we have Real Estate. We shall look at Real Estate in the next issue. Till then, bye!

Dinesh Gopalan
Fidelity India Finance
mobile: 9845257313