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10 Golden Rules of Investing
10 Golden Rules of Investing
For an intangible entity, time is starkly palpable. It seems to strum with glee when you make swift gains in the market; it's a sentient savant when you suffer losses; it can be an irksome sprinter for the ageing saver; a sluggish bore for a young trader. But mostly, time is a capricious companion, loyal to none, yet equanimous to all. We, at ET Wealth, have not been immune to its caprices, swept as the rest into its contrarian fold. So, during the economic slowdown, into which we stepped with our launch on 13 December 2010, we felt laden with our readers' expectations. However, two years later, having navigated you through financial undulations, we feel leavened by your response. Through it all, we have tried to maintain our own equanimity, which stems from our acute perception of your needs and the deep insight into personal finance. Between fielding time's whimsies and setting you on the right course, we have reached another milestone - we have turned two. It's a special occasion because in this short span we have learnt to tweak time's truancy to our advantage. In its contortions, we have found a constant. We call it the Golden Rules of Investing. A synthesis of the past learnings, these principles are our way of celebrating the present by securing your future. The mark of any rule is its universality and ability to transcend time. What we have framed for you are 10 canons that are based on these benchmarks, a compilation of our previous stories. They will act as a bulwark for your finances against the attenuating swipes of time. They will hone you into an aware investor in sync with your needs. Most importantly, they will help you grow your wealth, so that we can keep the promise we made at the time of our launch - that we would lead you to riches in this golden decade of investing. In the following pages, we will tell you how to build a safe portfolio; how to work towards a fret-free retirement; ways to defend against the crushing impact of the unforeseen; how to juggle your portfolio and when to cut your losses; how to deal with the trap of taxation; how to make the distinction between insurance and investment; the much1|P a g e
Rule 1: Know your worth before you begin To reach the finishing line, you must first know where the race begins. As any financial planner will tell you, figuring out your net worth is the first step towards formulating a successful financial plan. The best way to do this is by drawing up a list of your assets and liabilities. Use the table on the right to calculate your net worth. It will also give you a broad idea of your current asset allocation. Taking stock of your current status is necessary to help you make informed financial decisions. The slowdown may have affected your annual increment. Volatility in the stock market may have prompted you to stay out. Before you plan to invest, sit down and take a fresh look at your financial situation. Once you have figured out where you stand, find out your attitude towards investing. Your ability to take risks determines the investments you should opt for. If your stomach churns whenever the Sensex goes into a freefall, equity is not for you. Stick to the safety of debt options or take exposure to stocks through mutual funds. On the other hand, if a 20-25% fall in value doesn't upset you, equity can be a great way to build wealth. Another important trait is the keenness to conduct research before investing. Some people love nothing more than digging into financial statements and crunching numbers, while others might not have the time or inclination to plough through prospectuses and product brochures.
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Rule 2: Don't invest in a product you don't understand... Most of the people who write to us seeking financial advice have investments they don't understand. They are likely to know every random feature of their Rs 8,000 cell phone, but will be clueless about their insurance policies that are worth lakhs of rupees. Before you invest, you must fully understand how the product works and how you will gain from it. There are several products (especially insurance plans) that promise the moon and have complex features. Avoid these sophisticated products if you don't understand them. Investing
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...but don't skew your portfolio in favour of one asset The above-mentioned investment rule does not imply that you concentrate your investments in one or two asset classes. You may not understand equity, but this should not stop you from investing in equity mutual funds. As long as you understand that the fund manager will deploy your money in the stock market and your investment will move with the market, it is good enough. There are investors who buy nothing but gold, or invest only in bank deposits. Some invest only in real estate having been conditioned into believing it is the safest asset. The biggest problem with a concentrated portfolio is that a single crash can make you bite the dust. We saw this happen in 2008 when the equity market crashed. As the chart below shows, a diversified portfolio cushions the risk and generates stable returns. So opt for diversification.
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Rule 3: Do not invest and forget Don't think your work is done after you make an investment. In fact, it has just begun. You need to monitor and review your investments and take corrective measures if they go off the track. At least once a year, you should subject your portfolio to the financial equivalent of a CT scan. The outcome may not be very palatable, but some tough decisions are needed to
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Experts say you should review your investments once a year. However, some extraordinary circumstances may require you to rejig it even earlier. Here are a few such special situations: Marriage Wedding bells mean new goals, higher expenses and a change in risk profile. Your investments need to be overhauled. If your spouse also works, your investible surplus will go up. Chalk out a combined list of goals and plan your investments to reach them.
Birth of a child The entry of a new member in the family means additional responsibilities and expenses. You will add new goals to your list and, therefore, need to change your investment pattern. This may also require you to increase your life insurance cover and establish an emergency medical kitty.
Salary hike When your income goes up, your investible surplus rises. Ideally, you should distribute the excess amount across different asset classes in the same proportion as your investment mix. You can increase the SIP amount in your investments. You may also want to add a financial goal to your list.
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Windfall Any unexpected income or an annual bonus coming your way is another reason to change your investment portfolio. If the money comes to you as a lump sum, put it in a debt fund and start a systematic transfer plan to an equity fund. Loans If you have taken a loan, put off some of your investments to account for the EMI outgo. Rejig your investments by putting the non-essential goals on the backburner till the loan is repaid. When you repay a loan, you will have a bigger surplus to deploy. Black swan situations A sudden movement in the stock market, such as the crash of 2008, may warrant a change in your investment portfolio. You may need to rejig your asset allocation before a year to adjust to the change in the market sentiment.
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Rule 5: Factor in inflation while calculating returns Inflation affects everyone and its impact on the household budget is widely understood.
However, very few investors understand the impact of inflation on their investments.
This is a mistake because inflation should be factored into every calculation of your financial plan.
Even a modest 5% annual inflation can widen the gap between your nominal and real income to almost 20% in just five years.
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Over 40 years, this difference can widen to over 80%. So, don't plan your future based on nominal values. Factor in inflation to know the real value of your income and investments.
The post-tax returns from a bank deposit, which offers 8.5% interest, will not be able to match the rise in prices.
This is why planners don't recommend low-yield debt investments for the long term. Instead, they advise clients to take at least 15-20% exposure to equities to be able to beat inflation.
Inflation should especially be considered while planning for long-term goals like retirement and children's education.
Also take into account the fact that your consumption basket changes over the years. When you are single, education and healthcare inflation do not impact you (see graphic).
However, when you start a family, education expenses shoot up. As you grow older, healthcare accounts for a progressively larger portion of your expenses.
A Rs 1 crore insurance cover seems sufficient right now, but this might change when you factor in inflation.
Even 6% inflation will reduce the purchasing power of Rs 1 crore to Rs 40 lakh in 15 years.
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Rule 6: Buy insurance to guard against the unforeseen... No matter how careful you are, an eventuality can play havoc with your finances. It could be a medical emergency that racks up a huge bill or the death of the family's breadwinner. The only way to deal with these mishaps is to protect yourself adequately. Insurance is a costeffective way to safeguard yourself against the unexpected. In fact, life insurance is one of the most important ingredients of a financial plan. This one instrument secures all your financial goals and aspirations. One should have a cover of at least 5-6 times one's annual income. However, this is a rudimentary method and a more accurate calculation must take into account your expenses, current assets and future financial goals. Use the table below to find out the size of life insurance cover you need. Medical insurance is also very important. The rise in cost of healthcare means that even 2-3 days in hospital can cost Rs 50,000-60,000.
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Rule 7: Don't leave tax planning till end of financial year It is a perennial problem. Taxpayers wake up in March when their employer sends them a
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...but do not keep all of it in cash While the need for a cash cushion cannot be stressed enough, the problem is that many of us
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One of the biggest challenges for tomorrow's retirees is to ensure that they don't outlive their savings. This is a distinct possibility because of two factors: the rising cost of living and an increase in life expectancy. However, for many Indians, retirement is not as crucial as saving for their children. Whether it is for their education or marriage, or even to provide them with a comfortable life, children are the biggest motivators of savings in the country. This can be a problem because your retirement is going to be very different from that of the previous generation. Guaranteed pension, assured return from government schemes, relatively low inflation and the security of a joint family - the four pillars on which the previous generation's retirement planning rested - have either gone or will disappear soon. What's more, you will live longer, thus heightening the risk of outliving your money. Before you pour money into a child plan, make sure your retirement savings target has been met. Retirement planning should be your first and most important financial goal. By this we don't mean you should neglect your child's needs, but you can borrow for almost all other goals, such as child's education, marriage or going on a holiday. No one will lend you for your retirement expenses though. The early birds, who start putting away small amounts from the day they start working, have a distinct advantage over lazy grasshoppers, who think of retirement planning only after the first grey hair makes an appearance in their 40s (see graphic). It is also important that you don't dip into your corpus before you retire. Withdrawing money from your PPF account or missing the premium of a pension plan can lead to a shortfall in your corpus. If you want a dignified retirement, resist the temptation to withdraw from the investments earmarked for your sunset years.
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Rule 10: Learn to cut your losses Many investors believe that if they select a good investment and time their moves well, it is enough. However, the decision to sell, especially at a loss, is not as easy. Financial experts say that the small investor's portfolio suffers more due to incorrect decisions that are not rectified in time. Holding bad investments may be worse than not selecting the right ones. To be a successful investor, you need to have a selling plan in place and book losses if the situation so demands. Behavioural economists contend that our refusal to sell an investment stems from our aversion to loss. If our investment turns out to be good, we are happy to sell and feel good about the gains. However, booking a loss is painful, so we tend to postpone the regret we feel at having made the wrong decision. We choose to wait out, ignore, or worse, add more to a poorly performing investment, hoping to average out the cost. Therefore, cleaning up a portfolio is a tough task and calls for rational decision-making. Low-yield insurance policies, dud stocks and poorly selected mutual funds don't offer any value to the investor, but there is a deeprooted aversion to get rid of them. Many of the wrong decisions are taken when everything is looking upbeat. Those who bought obscure infrastructure stocks at the height of the 2007 euphoria are still holding them, hoping that they will be able to recoup their investment one day. Little do they realise that this is a drag on their portfolio's overall return. Had they booked losses in 2008 and shifted the money to any average index-based stock, they would have got something back. It is also important not to throw good money after bad. Don't book profits on good investments just to plough it back into underperformers. You will only be left with lemons. It is better to ride the winners than pump more money into losers.
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