THE NEED FOR FINANCIAL EDUCATION
Financial education is the solution. A lot has been done. A lot more needs to be done. In my nearly three decades as a financial journalist, I have been fortunate to interact and interview some of the biggest financial planning minds of this country. I am putting down some key learnings.
STEP BY STEP GUIDE TO BECOMING WEALTHY
Do not fear the word personal finance or investing! Since we have in the past never been exposed to this learning in our school or college, many of us tend to believe this is a subject that we cannot handle and hence push back our investing journey. It intimidates us. It need not. Personal finance is no rocket science. It is just a series of steps that require discipline and patience.
Many young people believe that investing or financial planning is something you do when you have a lot of money! Nothing could be further from the truth. India’s financial infrastructure allows an individual with as little as INR 500 to start the investing journey. In fact, the earlier you start the more wealthy you are likely to be, with the power of compounding—-something. We learned in school and forgot by the time we passed out—working for you.
WHY YOU NEED A FINANCIAL ADVISOR
The first step to financial planning is finding a financial planner. While we need a lot more financial planners in this country, we do have some extremely high quality registered financial advisors. Details of them can be found on the regulator’s website and one can access the person closest to us. In fact, while physical proximity is good, you can even through online video chats access the best planners in any city just like you would do with a doctor. In fact, you need to treat your financial advisor like a financial doctor just like you would treat your medical doctor for your health issues. A good way to find a financial advisor is like we find a doctor. We check with friends and family and scour the internet to find highly recommended doctors, we should do the same with finding a financial advisor.
Your financial advisor will draw out your entire financial plan as also the path to get to where you want to go. In fact, the first step to any financial planning is goal setting. Why are you investing? What are you investing for? When do you need money to fulfil your goal? Putting this down, is the first step to investing, and easy as it sounds, most people don’t do this simple exercise.
HOW MUCH RISK CAN YOU TAKE?
The next important conversation to have with your financial advisor is how much risk can you take? Can you see your investment move up and down? Can you stomach volatility? If yes, for how long? Are you wired to expect a guaranteed return? The answer to these among many other questions an advisor will pose to you will decide your risk profile. And whether you can invest in equities and if yes to what extent. Yet, most people start investing without undergoing this exercise and set themselves up for disappointment and anxiety.
Let us step back a little. Why do we need to invest? The simple answer is: Inflation. And building wealth to achieve our goals. Inflation is going to be a constant in our life for the next many years considering we are a fast growing developing economy. In fact, in the current times, even developed countries are logging record high inflation. The only proven asset class backed by years of data that has effectively beaten inflation over long periods of time is equity. Similarly, if we need to achieve long term goals like a child’s education or our own retirement, the proven asset class to build wealth is equity.
However, in the short term equity can be very volatile. Hence it is advised to consider equity as a long term asset class. Do you have the patience to stay the course? Most people unfortunately don’t and attempt to time their entry and exit into the market, something even the best experts find it difficult to do. As a result, they suffer losses, and abandon the asset class altogether.
What has often amazed me is we as consumers are so driven by discounts in everything we buy. We love to bargain and drive down the price. We rush to buy when there is a discount offer going on. But we do just the opposite with equity. We buy when markets are going up and sell when they are falling! This trend is changing given the record success of systematic investment plans or SIPs that allow you to put in a fixed amount every month and this achieves rupee cost averaging for you as you buy when markets are both up and down.
IMPORTANCE OF ASSET ALLOCATION
Once you have figured out your goals and risk assessment, comes the most important part of your investment journey. Asset allocation. And this where the role of the financial advisor becomes imperative. As the old adage goes: Never put all your eggs in one basket. To derive maximum returns, asset allocation is a must. It is important to remember that no asset class is linear. They all move up and down depending on the developments that impact their prices. And hence, to be confined solely to one asset class is not prudent. Experts say more than 90% of the returns you earn come from proper asset allocation.
Your asset allocation is a function of your goals and your risk appetite. For long term goals you may have more equity, and for short term goals, it could be more debt. Gold is an asset class known to counter inflation and financial planners recommend between 5-10% gold in your portfolio as a hedge against inflation. What is more important is to periodically review your portfolio to ensure your asset allocation is not disturbed by price movements. For example, if the equity component in your portfolio has gone past your recommended asset allocation, then it needs to be rebalanced. The rebalancing is best done by your financial advisor. It is usually done every 6 or 12 months.
It is very easy to get carried away when asset prices are rising and move away from the asset allocation that you started with. But that is a big mistake. And this is where discipline comes into play. You have to control emotions and stick to your asset allocation.
ALL ABOUT MUTUAL FUNDS
Once your asset allocation is in place, comes the stage of picking the right instruments and approach for your portfolio. Should you buy a bunch of good stocks directly? By all means if you have the ability to research on a regular basis and track developments in the company that are announced from time to time. Or should you invest through the mutual fund route, which gives a range of different options of schemes to suit your risk profile. You pay a small fee and then a team of professional fund managers set into action to invest your money.
Mutual funds are among the best regulated entities by market regulator SEBI. There are stringent requirements in place, to prevent potential fraud. Of course, market movements and their impact on your investment is your risk to carry. As the industry evolved, there are a wide range of mutual fund schemes available, suitable to an investor’s needs, risk and asset allocation. These are across equity, debt, gold and global assets. There are schemes that are hybrid in nature as well and invest in both debt and equity. In other words, whatever is your requirement, mutual funds have it available for you.
HOW MANY MUTUAL FUND SCHEMES DO YOU NEED?
The key question that then arises for investors is which scheme to buy? And how many to buy? This is again, where the financial advisor’s role becomes important. I have seen many people who have bought close to 50 mutual fund schemes! This is a big mistake. Each mutual fund scheme by definition invests in a number of stocks or debt instruments. In other words, its very purpose is to provide diversification to your portfolio that cuts down risk and enhances returns. So when you are buying too many schemes, you are over diversifying and buying the same shares through different schemes, while paying a cost of purchase. This does not serve any purpose for you. There is no right number of schemes that you should have, but you need to choose only those that meet your goals and risk profile.
DISEASE DOESN’T KNOCK AND COME: GET YOURSELF A HEALTH COVER
Even before you start investing, there is something else you need to do. Get yourself a health insurance policy. Most of us believe that the policy provided by the company we work for is sufficient. It is not. What if you quit your job? What if you face a lay-off? Given the rate at which the cost of quality medical care is rising, the Rs 2 lakh or Rs 5 lakh cover your company gives you is not enough. You need to get yourself at least a Rs 25 lakh cover and keep topping it up as and when your family expands.
The sooner you get yourself a cover the better. With age, policy issuance process and pre-existing diseases related exclusions start kicking in. In some cases, if you have suffered a disease you may not even get a health cover. The fast pace of digitization in the country has meant you can buy your health insurance at a click of a button sitting at home. What is the point of investing your hard earned money if one health setback is going to wipe away all your gains?
DEATH IS INEVITABLE. GET YOURSELF A LIFE INSURANCE.
Next comes life insurance. When do you buy it? As soon as you have a responsibility. This could be parents dependent on your income, spouse or children or even a loan that you have taken the liability of which will fall on your family in the event of your death. Focus on buying a term life insurance cover where you get a higher insurance cover at a low rate. Again, the earlier you do this the better, as the premium goes up sharply with age. So, best to lock yourself in at an early age and again keep increasing the cover as your responsibilities rise. In fact, there is a move by the regulators to dematerialize insurance policies as well and keep them in your demat account. This could be a gamechanger for consumers as you would have access to your policy in a consolidated manner and avoid loss of policy and unnecessary paperwork.
