How to align your Investments with your Personal Financial Goals

I have been invested in Equity mutual funds for the past one year and have barely made enough money in it even to pay your fees! I am worried – will I lose my money? If it is to continue like this, should I put my money only in Bank FDs – at least the interest rates are high for now and they are safer?

For the past few months, we have been getting such emails or telephone calls where people invested through us (or elsewhere) pose their dilemma. This clearly reflects the grief that almost everybody is experiencing with the state of stock markets today. Though the markets have run up quite well in the past 7 weeks, with some financial pundits pompously predicting that The Bull Run is Back, the volatility of this week has got the original question doing the rounds again.

While the question does indicate anxiety of investors, it also brings out the investors’ non-comprehension of correlation between one’s life-time goals and the various avenues available for investing. This further begets the question – how should one go about deciding how to invest his money, whether a lump-sum or monthly savings or both? This article will aim to sort out this basic issue.

The very first thing to understand is that if we do not know (or are unclear about) what we wish to save for, we will never be able to save for it!! It simply means that if we do not specifically save for life’s major financial goals, it will be very difficult to remain on track to do any meaningful investments. The temptation to dip into savings at the smallest pretext will be too much to resist, resulting in a scramble when those big-ticket expenses actually arrive. And what could be those financial goals – anything that consumes a lot of your money and is something which you have to or want to spend your money on. The goals could be children’s higher studies (graduation and post-graduation), their marriage, a comfortable retirement, regular domestic and/or international vacations, changing your car every 7-10 years, donating regularly for a charity etc. For example, if you know a particular saving avenue is to fund your daughter’s marriage, you would touch it for anything else only if you have your back to the wall.

The next thing that comes up is how to decide where to save the money? Primarily, money can be saved in four types of asset classes: Debt (eg, Provident Fund, Fixed Deposits, debt mutual funds, and Government schemes like NSC, Post Office schemes & Government bonds), Equity (direct stocks, equity mutual funds, ULIPs), Real Estate and bullion (precious commodities like Gold, Silver, Platinum and Palladium). Each asset class has its own peculiarity as below:-

Debt: Capital is protected but returns may just about match the inflation. A portfolio consisting of pure debt assets is not likely to be able to meet your long-term financial goals.

Equity: Investments in equity guarantee a roller-coaster ride in the short-term! Implying, one should understand that equity will have dismal returns and bumper returns at varying points of time. But carefully selected portfolio which is well-monitored can give returns far in excess of general inflation rate over a long period of time – generally beyond 3 years. Thus, equity is good for long-term but may be unsuitable for short-term goals.

It is said that you trade in ‘Debt’ while you invest in ‘Equity’, meaning that you should invest in debt-related instruments for your short-term goals (less than 2-3 years’ horizon) while invest in equity-related instruments for your goals beyond that time horizon. It also implies that, as a particular goal approaches nearer, move the money invested in equity for that particular goal gradually to debt assets.

Real Estate: Location, price and builder (if taking an under-construction property) are the 3 crucial aspects. General misconception that real-estate will only go up, has been proved wrong time-and-again. Also remember that real estate requires bulk investments, is fairly illiquid if wish to sell it in a hurry and there is a need to look at inflation-adjusted percentage returns of the property rather than only the bulk money returns. It is well documented that over a time-horizon beyond 10 years, equities in general give better returns than property in general! A portfolio consisting of largely real estate can lock you in badly when need arises for cashing it in a hurry.

Bullion: Referring primarily to Gold, bullion generally gives returns matching the rate of inflation. Notwithstanding the way Gold has risen in the past 1 ½ - 2 years, Gold should only be seen as a hedge against inflation, rather than as an investment tool.

With the above as background knowledge about various asset classes, how should one go about investing and saving for life’s future major goals. We give our take below:-

1. Decide on your life’s major Financial Goals and save for them. And while doing that, do not forget about Retirement, where you are likely to spend around 20-30 years of your life. Another word of caution, if you are in receipt of your employer’s pension, don’t count on it to entirely fund those 20-30 years unless you are ready for major financial compromises in later years of life.

2. Invest as per your Risk profile. How much of equity-related products are you comfortable with? Does huge investment in property make you lose a night’s sleep. Take a test on our website at http://www.humfauji.com/risk.aspx.  

3. Decide your Asset Allocation Percentage. Not all eggs in one basket. Change and rebalance it as per changing times – markets, your age and your requirements. Invest in assets with negative correlation amongst themselves, eg, last 5 years’ data indicates that there is hardly any correlation of equity with Gold as also debt instruments in India while it has a very high positive correlation with real-estate. Debt instruments for short-term goals, equity for long-term, some Gold for balancing and some property (one house to stay, one for good rentals).

4. Look beyond Fixed Deposits as part of fixed income allocation. Debt instrument returns get hugely affected by their taxability aspects. Since their returns barely match the inflation, if you further get taxed at 30% on it, a FD of 9.5% will effectively give you only 6.56% return! Instruments like Debt Mutual Funds are far more tax-efficient while being almost as safe.

5. Plan investments across various time-frames. Plan for short-term, medium-term and long-term. Do not mix them. If due to some urgent unavoidable requirement you have to take out money from your long-term funds, do remember to fill back that ‘bucket’ at the earliest opportunity.

6. Tax saving should not cloud your investment needs. Do not invest a large amount or take on a long-term commitment merely for the sake of saving tax. Eg, a Government officer taking medical insurance to save tax under IT sec 80D, buying a property only to get tax advantage on home loan, insurance policy only for tax purpose, are all potential money-wasters.

7. Once invested, be patient for results. Equities will be volatile in the short-term; Property will not shoot up just because you have bought it now; Debt returns will just about match inflation... However, do not hesitate to book losses if you find that results do not match expectations even after you have given it its due time.

8. Invest in an asset class as per its peculiarities. Each asset class has its peculiarities which should be understood and researched BEFORE investing in it. The best way to invest in equity mutual funds is through Systematic Investment Plans (SIPs) and Systematic Transfer Plans (STPs), lock-in into debt products when interest rates are high, invest in all equity-related products when everybody is professing nothing but gloom and doom, etc.

9. Invest in a Financial Advisor and a life-time financial plan for yourself. Like you need a doctor for good physical health and a Guru for good spiritual health, you need a Financial Planner for your good financial health. Similarly, like a full-body health check-up, you also need a life-time financial plan to be made for you so that you know how to reach where you want to go to.

Investments for the recently Retired in India

Retirement marks the beginning of a new phase in an individual's life. It's a transition from a lifetime of work to a time when one can relax, spend time with the family and pursue other interests, which somehow take a backseat when on a regular job. Not only this, retirement also marks a transition in one's finances. With a regular stream of income no longer available, the savings made over one's working years now have to provide for all his needs. Even if one decides to go in for a second career (eg, in case of Defence Officers who retire early or others who may find another job in private sector due to skills acquired during working life), it will be for a limited period of time till, say, 60-65 years of age. Taking a life-expectancy of 85 years, there are still 20-25 years of non-earning life to be lived, with a challenge of increased expenses (large number of career-related perks not available now) and desire to maintain at least the same living standard as while earning. For such investors, capital protection and liquidity are priorities. In this article we profile some investment avenues that retirees can consider adding to their portfolios.

Retirement can be an ugly word if you do not have an investment plan and have no idea how inflation can deplete your finances. But it need not be if you can ensure a steady flow of income that can sustain you for 20-25 years after retirement. How does one go about it? First assess the amount you need per month depending on your expenses and lifestyle. Then, based on your corpus and risk appetite, opt for an appropriate scheme. Instead of investing in a single scheme, do so in a bunch of instruments, which not only assure regular income but also allow your corpus to grow in tandem with your withdrawals and rising inflation. This strategy should alter with age or stage of life after retirement. So, for the first six to eight years after you retire, allow your funds to grow at faster rate than the withdrawal. Even as you use the interest earned through debt options to meet your expenses, invest in equity through mutual funds or monthly income plans. In the next 10 years or so, your withdrawals should broadly match the growth of your portfolio. As you look at a higher monthly income through systematic withdrawal plans, you can reduce your exposure to equity. Beyond this period, you can use more of invested capital and significantly reduce the focus on growth. If you are not able to sustain the corpus and own a house, opt for the reverse mortgage scheme

Notwithstanding the above, there is a misconception amongst such investors that one should invest only into extremely safe avenues on or nearing retirement. It has to be kept in mind that the primary aim of all investments is to make the money grow more than inflation, and this aim remains constant, whether you are still working or retired. To explain this, consider Indian scenario where the average long-term annual rate of inflation is about 8%, implying that whatever costs Rs 100 today, will cost Rs 108 next year. Thus, if your income-tax adjusted returns are not anything more than Rs 8 per year on that Rs 100, then the actual worth of your money is effectively getting eroded each year. The wider implication of this is that, while your expenses will rise with inflation, you will have lesser money available each year and a time will come when a cut-back in the standard of living will become imperative. The only investments that make it possible with adequate liquidity are necessarily equity-related like stocks, mutual funds and ULIPs. However, one has to take a call on how much risk is acceptable to him/her. Those retiring from a job which provides them a pension, like Government employees, are a bit lucky as they get pension on retirement; but there is one negative thing attached with this – pension keeps people in illusion that pension will be sufficient for them to have a comfortable retirement for all their expenses like household expenditure, leisure activities, vacations, repairs & maintenance of house, social obligations and maybe some liabilities which are still balance to be tackled.. They forget that pension will be close to half of their income, the basic pension gets frozen with only DA rising over the years (except maybe on a Pay Commission review) and that the expenses that are currently borne by the exchequer, are not available after retirement.

Ideally, the entire corpus available with an individual on retirement (as also additional monthly investments, till the capability exists) should be related to individual goals like children’s education and marriage (whatever liability is still balance at the time of retirement), steady and steadily increasing regular income, vacation expenses, social obligations etc, and availability of enough liquidity in investments so that emergency requirements can be easily met. To this end, the money available needs to be invested in an array of instruments which meet the desired financial goals while still taking only those risks which are acceptable to the investor.

Likewise, the retiree's requirements will also play an important part in the portfolio creation. For example, a retiree who is well off and supported by his family may not need to fend for himself. Instead he might be keen on investing for his grandchildren and other family members. In such a scenario, the investment tenure goes up, as does the opportunity to take on higher risk; equity-oriented funds emerge as a very feasible option for a longer time-frame.

Finally, don't undermine the importance of a qualified and experienced investment advisor. Powered by expert advice and prompt service, a good investment advisor can ensure that your post-retirement investments become a hassle-free affair.

(In a sequel to this post, we will discuss the actual investments available to retired investors and how to choose what is good and comfortable for them)