“I started investing at the age of 11 but regret getting late”. These are the words of one of the greatest investors of all time – Warren Buffet. Can you imagine the immense potential of investing early. No, we are not saying begin investing at 11, we’re saying begin as early as possible.
But lazy as we are, we let our hard earned money sit idle in the savings account and a plan to invest sits at the bottom in our priority list. Specially in our 20s, when the newfound wings of financial independence make us spend on things we have always wished for. Spending money is not wrong, but only if it doesn’t come at the cost of compromising your investment contributions.
If you’re wondering how to begin your investment journey? Let Worth Explain how you can take your first steps, despite having next to no experience.
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1. Learn the basics first
If words like
wealth creation, bull market, mutual funds, stock market, capital gains, equity funds, portfolio returns, bull market etc. scare you? If the answer is yes, then the first step is to gain financial literacy. It’s simply the lack of financial literacy that makes people reluctant to invest.
The best thing you can do at this stage is to develop the habit of reading – online personal finance websites, business magazines, financial newspapers, following financial bloggers and experts, etc. This will give you a solid foundation on which to create your building of investment on. Gradually, you’ll gain the confidence to deep dive into the different financial products and how to utilise them.
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2. Look at the options you have
Once you begin to develop a keen interest in the subject, the next step can be to explore the various investment vehicles you have at your disposal, such as Fixed Deposit, Mutual Funds, PPF, NPS, etc. Each of these contain within themselves a whole bunch of sub categories each one to cater to different investor needs. Being aware of the diverse investment options assists in creating the appropriate portfolio involving the right mix of investment vehicles with which to achieve various life goals. After all, maximising returns and minimising risk is the primary aim of a balanced portfolio.
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3. Figure out what you stand to lose
The next step is to Identifying your risk appetite. This is primarily determined on the basis of factors like stability of income, preferred degree of liquidity, and the investment horizon. All these parameters determine whether you are risk averse or a risk taker, and also the degree of risk – low, moderate or high. Based on the identified risk appetite and investment option should be chosen.
For instance, someone aiming to invest for a long term goal such as owning a house after 10 years, the chosen investment portfolio can be a balanced one involving a mix of both debt and equity funds for a risk averse investor. Whereas a moderate to high risk appetite holder can opt for a portfolio solely invested in equity mutual funds for the same goals and investment horizon.
Wondering why bank FD or PPF weren’t suggested as vehicles to achieve the long term goals? That is because the returns of these investment options are much lower than mutual funds, especially equities, in the long run. More often than not, the sub optimal returns of bank FD, PPF, NPS etc fail to provide inflation adjusted returns, whereas equity mutual funds on the other hand, have depicted over the past, that they consistently outperform both inflation as well as other asset classes by a wide margin over the long run.
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4. Give yourself a target
Your investment horizon depends upon your financial goals. A long term goal such as your retirement involves a longer investment horizon and would best be achieved through majority investment in equity. since equities have consistently proven to yield higher returns than all other alternatives such as PPF for long term investments. Whereas, if your goal is a short term one requiring an investment horizon of just 1-2 years, debt funds or high yield FDs can be a suitable instrument, as these involve nil or low risk and offer decent returns for small periods.
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5. Don’t aim for money, aim for goals
Each one of us has different dreams and life goals which we prioritise according to our lifestyle, income, age etc. It’s not an option but a necessity to be clear regarding the financial goals for which we intend to invest. A portfolio built in the absence of earmarked goals results in erratic decision making and sub-optimal investments. Remember that each goal requires a different approach. And when you tie your investments to separate financial goals, you provide a direction to your portfolio and enable yourself to maximise the potential returns and minimise the risks.
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6. Don’t give it all away to the tax man
Investments and taxation go hand in hand, don’t they? So, when beginning to invest, one should also learn of the taxation rules that apply to the various instruments. Besides the risk and returns, the taxation of the principal, interest (returns) and maturity value also needs to be taken into account. To make matters confusing, there’s different tax liability for each option such as PPF, bank FD, mutual funds etc,.
For instance, PPF falls in the EEE (exempt, exempt, exempt) category, implying that its principal, interest earned and maturity value are all exempt from taxes. As far as Bank FD is concerned, the interest earned is added to your income and then taxed as per your income tax slab. Similar is the case of short term gains of debt mutual funds. Whereas long term gains on your debt fund units attract a tax rate of 20% after indexation.
And for Equity funds, 15% rate of tax on short term capital gains is levied, whereas long term capital gains get taxed at 10% (only for gains above Rs 1 lakh in a financial year).
7. Learn the golden rule of investing
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Early bird catches the worm is an adage most of us must have heard. This holds true when it comes to investing. The sooner one begins investing, less the contribution required to achieve that goal and higher the chances of reaching the goal even before time! Developing the habit of early investing not only instils financial discipline but also enables the investor to benefit from the power of compounding. With the power of compounding, the earnings from invested amounts get reinvested back into the principal, hence resulting in earning exponentially higher returns over the long term. This mechanism turns out to be very helpful in achieving big-ticket and long term financial goals.
Here is an example to further emphasise the importance of investing early.
A 25-year-old can accumulate a corpus of close to Rs 25 lakh by beginning to invest just Rs 5,000 monthly till the age of 40 years in equity mutual fund SIPs (assuming a conservative expected rate of return of 12%). Whereas for the same corpus to be created by the age of 40 for someone beginning much later at the age of say, 32, a much higher SIP monthly contribution of close to Rs 15,000 would be required.
8. Don’t be scared of the stock market
Stay away from equities or stick to safe investments like debt funds or FDs and PPF are some common advice that we get from friends, colleagues or family. This traditional mindset of being okay with low or moderate returns by hanging on to ‘safe’ investments is what holds back a sizeable chunk of investors from the massive potential of equities.
Let’s clear the air for you. As equity investment’s returns are linked to the stock market which of course, keeps fluctuating. They tend to be exposed to high degree of volatility in the short term, but in the long term, equity as an asset class has outperformed both inflation and fixed income instruments by a wide margin. This makes equity the most suitable asset class for wealth creation towards achieving long-term financial goals, especially those involving accumulation of huge corpus.
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9. Drop by drop
Instead of compromising on your liquidity and straining your finances to create a large corpus, it’s wiser to go for Systematic Investment Plans (SIPs). These allow investors to invest small amounts of money at regular intervals such as monthly, quarterly etc. on a predetermined date, in order to build an adequate corpus over the years. Since the SIP amount is auto-debited from the investor’s account on the predetermined date, this ensures regular and disciplined contribution towards the desired corpus.
As markets are volatile in nature, regular contribution also helps in rupee cost averaging. In other words, it averages out the cost at which the investor buys mutual fund units. Presence of this concept eliminates the need to time the SIP investment and also enables the investor to reap higher returns due to the power of compounding.
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Last but not the least, remember that wealth creation is a long-term process and there are absolutely no shortcuts. Besides the above steps, remember to follow a disciplined approach towards your investments and let the power of compounding do the rest. Let it make your money work for you!
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