Everyone has needs and wants. Someone might need to buy a house, while another might want to buy a phone. The trick lies in ensuring that you have enough money to take care of your needs when they arise rather than having to borrow or buy on credit. It is important to calculate the needs that one has before making investment decisions.
The first step is to chart out all wants and needs and differentiate between immediate and long-term ones. Then, prepare a timeline of when each need may have to be fulfilled.
Once the timeline is fixed, one needs to look at different investment options and, ideally, start saving early even for long-term needs to benefit from the power of compounding. For example, let us assume you have a need which will cost R50 lakh in 10 years and the return/interest you can earn is 14%. You need to invest R18,000 every month for 10 years at 14% to reach the financial goal. However, if the goal is stretched to 15 years, with everything else remaining the same, the amount of monthly investment will only be R8,000.
It is important to understand and monitor one?s cash flows, that is, from where the cash comes in and where it gets expended. With regards to income, one should also be sure of how long that particular income stream will last. Prepare a budget based on past financials and predict the probable future income.
It is crucial to factor in inflation. If the income exceeds expenses on a consistent basis, the financial plan is working for you, or else it?s time to revisit the plan.
Ideally, one?s investments should be split into short-, medium- and long-term, based on the timeline of goals. Accordingly, investments should be made in different instruments and asset classes. Apart from the time horizon, you should also understand your risk appetite and invest accordingly. The lower the risk taking appetite, the more gilt or debt instruments should be used and vice-versa.
Finally, choose investment options that go well with the nature of the goals. For example, if your goal is to send your child abroad for education, it is advisable to invest money in a Public Provident Fund (PPF) since it gives tax-free fixed interest rate, security of the principal and income-tax rebate.
On the other hand, if you plan to invest for your retirement, it is advisable to invest via the National Pension Scheme (NPS), as it is the cheapest market-linked retirement option available. One can also claim tax benefits for investing in NPS under Section 80C.
Debt products like bank fixed deposits and debt funds offer reasonable returns with safety of capital. However, returns from FDs are taxable.
It is advisable to invest in mutual fund through the systematic investment plan (SIP) route, which gives better returns than most instruments but at a higher risk. People investing through SIPs tend to purchase more units when the market falls and fewer units when it rises. Therefore, the average cost per unit declines over a period of time; thus, making it an effective tool of risk management. However, this benefit can be availed of only if you stay invested for the long term as markets are volatile.
Anil Rego
The writer is founder & CEO of Right Horizons
