Similarities In Your Investment And Car Journey

An investor embarks on his investment journey to attain his financial goals. Metaphorically, we can compare his journey with a car journey where he or his chauffeur drives the car to reach his desired destination (financial goals). It is imperative for a traveller to plan meticulously for a hassle free and smooth journey. Similarly, an investor must also plan his investment journey meticulously to avoid a bumpy financial ride.

Start Early – an early start in the morning helps to beat the rush and traffic on the way and helps you to reach the destination on time. If an investor starts investments early in his career, then he avoids the cost of delay. If Mr Early invests ₹10,000 per month from the age of 25, then he would have invested ₹36 lakh by the age of 55. However, Mr Late who starts at the age of 35, will have to invest ₹ 15,000 per month for a similar investment. However, the cost of delay is heavy for Mr Late whose wealth, till the age of 55, will grow to ₹ 2.27 crore at 15% assumed rate of return, whereas, Mr Early’s wealth would be ₹ 7.01 crore – a staggering difference of almost ₹ 5 crores. In case, Mr Late wants to catch up with Mr Early then he will have to make a monthly investment of ₹ 46,240.

Many Halts –if the traveller takes many halts during the journey then he will reach the desired destination late or must over speed to make up the lost time. Ideally, a halt every two to three hours is advisable to help the chauffeur and the passengers freshen up. Similarly, an investor who stops his SIP frequently will miss attaining his financial goals. We considered an example of a 10-year investment journey, wherein Mr Regular did not stop any of his monthly SIP instalments but Mr Halter took three halts wherein he stopped his SIP for 12 months each in between. Behaviourally, an investor normally does this due to a cognitive bias called regret/loss aversion. So, Mr Regular accumulated 6.401 units by investing ₹ 12 lakh through ₹ 10,000 monthly SIP and his corpus value was ₹22.78 lakh. On the other hand, Mr Halter could only accumulate 4102.628 units by investing ₹ 8.40 lakh through ₹ 10,000 monthly SIP and his corpus value was ₹ 14.60 lakh. Suppose, Mr Halter had taken only one considered halt of 12 months to watch the falling market and review/rebalance his portfolio then he would have accumulated 5775.831 units and his corpus value would have been ₹ 20.55 lakh.

Investor and Financial Advisor Relation – typically the driver controls the car with the accelerator, clutch, brake, and the steering. He decides when to drive fast or slow down, change gear or the turn the steering. In the same way, based on the market inputs, his experience and advice from his financial advisor the investor makes the final call regarding his investments. His financial advisor is his co-driver, cum navigator who guides him from time to time about what lies ahead in the driver’s blind spots, the turn ahead or the traffic jam conditions prevalent. A good financial advisor should not be commission driven and render dispassionate advice that has a financial rationale.

Equity the Accelerator – like the accelerator of a car through which the driver controls the speed, the investor controls his portfolio growth through its equity component. If he finds that the markets are falling, then he should top up or invest more to buy low akin to the driver pressing the accelerator to speed up when he finds that there is less traffic and roads are free. However, if he over speeds then it might lead to a crash and so should the investor beware of over-investment in equity, which is not commensurate to his risk profile. If the driver does not maintain adequate speed or goes very slow when he runs the risk of late arrival at his destination. Analogously, if the investor does maintain adequate resources in the equity component of his portfolio, proportionate to his risk profile, then he runs the risk of missing his long-term financial goals that are most achievable by wealth creation through equity.

Liquid Funds like Fuel Tanks – when you commence the car journey, you fill up adequate fuel depending on the distance of your journey. Likewise, before making a systematic investment the investor sets aside adequate cash in his bank account to start a SIP or invests it in liquid funds to start an STP. The main advantage of systematic investment is that it helps the investor to achieve rupee cost averaging as he buys more when the markets are low and vice versa. Parking the funds in liquid fund vis-à-vis leaving them in the bank accounts give the investor some additional advantages as follows: Firstly, their average annualised returns are 6 to 7.5%, unlike bank savings accounts that vary from 3.5 to 6%. Secondly, the total returns earned during the financial year through the bank interest are taxable as per the investor’s applicable IT slab rate within the same financial year; whereas, the short or long-term capital gains from the liquid fund are taxable only on redemption. Thirdly, there are no TDS applicable on liquid funds whereas banks deduct tax at source for interest earned in a financial year from savings and fixed deposits more than₹ 40,000.

Fixed Income Instruments Keeps the Portfolio Grounded – fixed income instruments pay investors fixed interest payments until its maturity date. At maturity, the concerned bank/corporation repays the principal amount invested. Bonds are the most common types of fixed-income products, which can be issued by governments and corporations. In the event of a company’s bankruptcy, it pays fixed-income investors before common stockholders. Therefore, these are safer investment options vis-à-vis equity and some even carry a sovereign guarantee. In other words, they keep the portfolio grounded and lend it safety, much like the four wheels of the car. The driver controls the drive to these tyres through the gearbox, which changes the ratio by enmeshing or delinking different sizes of gear wheels when the speed increases or decreases. Likewise, the investor also changes the cash flow into his fixed income instruments depending on his requirement of capital protection or wealth creation. Some of the commonly used financial instruments available in India in this category are the bank and post office deposits (Fixed deposits, Recurring deposits, Senior Citizen Savings Scheme, Provident Fund), government and corporate bonds and fixed deposits, mutual fund fixed maturity plan schemes, National Savings Certificate, Kisan Vikas Patra and-Convertible Debentures. Most of these instruments fall under the exempt-exempt-tax (EET) category, are liable for TDS and their returns taxed as per the applicable tax slab rate of the investor in his hands. Only the PF enjoys the exempt-exempt-exempt (EEE) status for taxation and its returns non-taxable in the hands of the investor.

Retirement Planningretirement planning is probably the best way to exemplify the above metaphors. Please see the first table below to understand that it is better to start the investment journey early to avoid paying a heavier SIP later. The second table exemplifies that to meet the desired financial goal, an investor must adopt an aggressive approach during his early years of career. This way he will invest smaller monthly SIP instalment or one-time lump sum amount. If he is overcautious and adopts a conservative approach then his lumpsum investment more than quadruples and his monthly SIP instalment more than triples. In the case of a moderate investor, the lump sum amount more than doubles and the monthly SIP instalment increases more than one-and-half times.

PENTAGON OF PERSONAL FINANCIAL PLANNING

Lot of us leave our financial planning to our parents during the early years of our career or to our financial advisers during the latter half of our lives. It is your money and leaving it to others to plan your finances is escapism due to lack of knowledge. It is not difficult to crack the numbers and plan your finances wisely. After all, you are the best person to know your needs and goals. In this article we give you an insight into five important aspects of financial planning that you must know and understand.

First and foremost is financial discipline. One must understand that a monk seeking self-realization (his goal) leads a rigorously self disciplined life. In the same way, you must also lead a financially self disciplined life to realize your financial goals. A sure way to achieve this is to inculcate the habit to ‘first invest and then spend’. Lot of us tend to first meet our expenses and then invest what we manage to save. Warren Buffet had once famously remarked, “If you buy things you don’t need, you will soon sell things you need.” The habit to invest before spending helps one to differentiate between his needs and wants. Therefore, it mitigates the habit to overspend on wants, a widespread financial indiscretion. Once you have decided to invest first and spend later, then you must invest regularly to achieve rupee cost averaging to beat the market volatility. For the market related instruments, this is best done through a systematic investment plan (SIP) or systematic transfer plan (STP) for mutual funds or systematic equity plan (SEP) for securities. In case of fixed income products, you have the option to invest through monthly installments in recurring deposit (RD) or public provident fund (PPF).

Second important aspect is goal formulation. Half the battle is won if one correctly formulates his financial goals. Your financial goals may include purchase of house, children education and their marriages, your own retirement, purchase of consumer products, vacations, and creation of emergency funds etc. Simply put, it entails that you first list out all your financial needs or requirements along with their tentative year of realization. Then calculate the number of years to their realization from the current year. This way you can classify these into short, medium and long-term goals. Goals falling between 0 to 3 years will be classified short-term, 3 to 7 years will be medium term and above 7 years is long term. This will then help you to correctly invest in the appropriate financial product. Ensuring capital protection is the singularly important consideration to meet the short-term goals. Therefore, one must invest in fixed income products like fixed deposit (FD) or RD, or ultra short or short-term debt mutual funds. In the case of medium-term goals, one must look to achieve growth of the investment while ensuring capital protection. Therefore, investment in balanced schemes or accrual debt schemes of mutual funds, or tax saving FD or bonds (5 to 7 years tenure) or PPF is a good option. For long-term goals wealth creation is the main consideration. Therefore, an investment in direct equity, equity oriented mutual funds or unit linked insurance plan (ULIP) is a good option. For the conservative investor, long-term debt (hold till maturity) mutual funds are a suitable option.

Third is the aspect of taxation. If you only concentrate on investments based on returns and not keep taxation in mind, then you may come to grief at the end of the financial year when your tax return will show large amount that you owe the taxman. In so far as taxation is concerned, you must first understand the different income tax sections under which one can save tax. You should judiciously invest to save maximum of Rs. 1.5 Lakh under Sec 80C under various available financial instruments. Take a medical insurance policy for yourself and your dependents that will provide you a relief of up to Rs. 60,000/-, if senior citizens are involved. One must also try and capitalize on home and education loan interest repayment deduction under Sec 24 and 80E respectively. Similarly, use Sec 80GG for saving from HRA. Next, is the implication of short and long term capital gains (STCG and LTCG) on various mutual fund schemes or securities, tax on dividend distributed income and income tax on fixed income products. After the 2018 budget, all equity mutual fund schemes and securities are taxable at @15.6% for STCG and other than equity are taxable as per applicable income tax slab rate of the individual. Further, all equity schemes have now been included under the ambit of long-term capital gains (LTCG) @10.4% without indexation and other than equity schemes @20.8% with indexation. Although all dividends are tax free in the hands of the investors, however, companies have to pay dividend distribution tax (DDT) @11.65% for equity oriented schemes and @20.8% for other than equity oriented schemes, which implies lesser dividend payout to the investor. All these tax rates include the surcharge and cess. When it comes to returns from interest income, they are mostly taxable as per the investor’s applicable income tax rate, except investments in PPF/EPF, Sukanya Samriddhi Yojana (SSY) and ULIP that enjoy the EEE status (exempt during investment, accumulation and redemption phases).

Fourth is to understand asset diversification. Proverbially, asset diversification implies that you don’t put all your eggs in one basket. The primary asset classes are real estate, equity, fixed income and gold. You can invest in each of these either directly or through a broker. Digitization of markets has brought in tremendous transparency for the learned investor to take well researched and considered decision to avoid falling into a trap. One must carry out diversification to beat the market volatility after his financial goal planning and assessment of risk profile, which is function of his age and liabilities. Overexposure in any these asset classes run the risk of either capital erosion or low returns that cannot beat the inflation. Moreover, before investment you must also understand their liquidity value so as to maintain balance between cash and asset holding. During your investment and accumulation phases of life, plan and invest with the aim to achieve ‘cash abundance and minimal assets’ for a comfortable and hassle free post retirement years.

Last but not the least is the Portfolio Review and Re-balancing. The first phase of reviewing the portfolio entails going through your entire portfolio in detail to see if it is on track to meet your designated financial goals. It must also find out the out performer and under performer schemes in your portfolio. In the second phase of re-balancing, one must exit from the under-performing schemes after due consideration for the exit load and tax implications while holding on to the outperforming schemes. In case your portfolio is not in sync with your financial goals then one must carry out asset diversification to re-balance after considering his risk profile. Re-balancing is best achieved through a judicious mix of switching from one scheme to another of the same fund house, redeeming to invest in an outperforming scheme of another fund house through SIP or STP, or merely starting a fresh SIP to bolster the portfolio.