Managing Your Investments, Better

By Ankur Kapur, CFA, CFP

Chief Investment Officer, Plutus Capital

Topic 1: Common Investment Mistakes

A lot of investors commit mistakes and then their investment portfolio suffers. Let’s look into some of the most prominent mistakes that you should avoid.

 

No clear investment objective or plan

If you don’t know where you are going, you will probably end up in the wrong place. This is one of the biggest mistakes that most investors tend to make while starting investments—they do not have their life goals in mind when they invest. The longer you postpone getting your objectives baked into a financial plan, the harder it will become for you to meet these.  

A lot of investors commit mistakes and then their investment portfolio suffers. Let’s look into some of the most prominent mistakes that you should avoid.

 

No clear investment objective or plan

If you don’t know where you are going, you will probably end up in the wrong place. This is one of the biggest mistakes that most investors tend to make while starting investments—they do not have their life goals in mind when they invest. The longer you postpone getting your objectives baked into a financial plan, the harder it will become for you to meet these.  

Trading too much, too often

Too many people trade too much, too often and do not reap the benefits of long-term investing and sensible asset allocation. Repeated trading and modification in investments usually lead to lower returns and higher transaction costs. If you want to benefit from long-term wealth creation, patience is the key.  

 

Lack of diversification

Different assets carry different kinds of risk and return potential. Hence, diversifying your portfolio is very important to insulate yourself from shocks in a particular asset class. More specifically, adequate diversification across different asset classes can help in sustained long-term wealth creation. That being said, excessive diversification and exposure to too many stocks/funds can also negatively impact the returns of the portfolio.

 

High commissions and fees

Paying a higher fee on your investments over the long term can have a significant impact on the performance of your portfolio. The money you pay as fees and brokerage every year compounds along with your investment returns over time. Many advisers will often recommend high-cost funds or high-cost advisory services to you—don’t let these high costs eat away your returns. It is extremely important to choose investment options that are reasonably priced.

Chasing short-term returns

A high return asset is a very tempting proposition but past returns are no assurance of higher returns in the future. It is important to focus on the whole picture and not disregard the risk you carry on your investments.

 

Timing the market

While there are indicators of various kinds that reflect the market trend at any given point of time, this does not mean that one can accurately determine when to enter or exit the markets. The belief that one can catch the top and bottom is a myth.

 

Ignoring inflation and taxes

Most investors focus on absolute returns instead of looking at real returns. To arrive at actual returns from your investments, you need to adjust for the impact of inflation and taxes. A LIC agent often talks in terms of absolute values, can have a serious impact on your decision making. For eg. They would say Rs 40k per year will grow to Rs 30L in 35 years. Sounds good? But it's not. It is just 4.1% p.a. return lot lesser than 7% p.a. inflation in India. Start thinking on post-tax annualized return.    

Topic 2: Power of Compounding

“Compound interest is the eighth wonder of the world. He who understands it earns it... he who doesn't... pays it.”

 

- Albert Einstein

Topic 3: Where do you stand today, financially?

No matter how much you know about investments, stock markets, credit cards and insurance, if you do not know your money well, you are most likely to fail in planning financially. The first and perhaps the most important step in financial planning is to know your money i.e., your financial position well and then be able to manage it wisely.

What makes up your financial position or Net Worth?

 

Your assets and liabilities: The amount of assets—items of value—you hold, is a precise indicator of your current and future financial position.

Assets tend to add to your income e.g. investments. Or they help reduce expenses, as in the case of owning a house—it saves you taxes and rent. Thus, assets help to strengthen your financial position. On the other hand, liabilities weaken your financial position.

 

Liabilities—something that you owe is a liability.  
 

More assets and lesser liabilities would help you better your financial position and strengthen your money.

 

Just like any disease is best treated when detected in an early stage, similarly with regard to your financial health recognizing early signs can help you take the right steps and prevent great disasters for yourself.

 

Watch out if your liabilities including credit card bills are more than assets. If they are, you should first bring down your liabilities to manageable level before you start investing.

Topic 4: Understand your cash flows

Simply speaking, it’s the money that is coming in and money that is going out.

Where does your money come from?  List the sources of your income (e.g., work, rent, pension plan) and the amount that comes in from each source each month.  It is always a preferred option to look at the after-tax income that will be available.

Do you check your bank account at the end of the month and wonder where all the money went? 

Before you can manage your money, you have to know how you’re spending it. I have seen with most of the affluent clients, they even keep a record of as low as Rs 500/- spent on a grocery item. Get in the habit of recording your expenditures once a week.

It’s useful to separate your expenses into 2 categories:

  1. Fixed Needs – Necessary expenses that stay the same from month to month, e.g., rent, phone bill.

  2. Variable Needs – Necessary expenses that may vary from month to month, e.g., petrol expense, food. This also includes discretionary expenses such as shopping.

 

If you have a monthly savings goal (and you should!), include it as an expense.  It is much easier to save money if you’ve planned for it in your budget.  And it’s important, too: if you run into unforeseen expenses, you’ll want to be able to pay them without going into debt.  And even if nothing goes wrong, having some savings will help you follow your goals in the future.

Topic 5: Time value of money

This is probably the most important concept if you want to grow your wealth. Interestingly, this was the only thing taught to us back in school, maybe 6th or 7th grade.

 

A = P X (1+r) ^n

 

Looks familiar. This is a formula to understand how your money grows if invested at a certain rate ‘r’ for a certain period ‘n’.

Everyone knows that inflation eats into savings and increases costs, but do you know by how much?

Inflation is a rise in general levels of price of everyday goods, over a period of time. Due to inflation, a steady income alone is not enough to help you reach your financial goals.

For example, the current cost of a college admission may be Rs. two lakhs. But after 5 years, the cost would typically be higher. While saving for a goal, therefore, it is important to estimate the future value of the goal because that is the amount that has to be accumulated.

 

The future value of a goal = Current Value x (1+ Rate of Inflation) ^ (Years to Goal)

 

There are two ways to counter this aspect.

  • Start investing as soon as you can to take advantage of the power of compounding.

  • Seriously consider investments with a track record of beating inflation.

Topic 6: Goal-based Financial Planning

Just as daily tasks have allocated time slots, similarly you need to have a slot in your life to manage and grow your money. 

 

There are many ways to do this goal-based assessment but one of the most intuitive ways is to bucket them. You start with the lowest bucket which is kind of given that you need to plan, for your example your retirement. After this bucket comes, more of ‘want’. 

This would include goals like a car for office commute. The top bucket can be more aspiration, second home etc. Every person is different and so are these buckets.

Example, for one-person international vacation maybe a want but for the other, it could be an aspiration. This is precisely the reason, there can’t be any template to do this exercise but only a broad structure.

 

Our goals can be bucketed into three categories:

 

  1. Need: These goals are extremely important to us and provide protection from anxiety.

  2. Want: These goals are not as important as the “needs”; however, they ensure that we maintain a desired standard of living.

  3. Aspiration: These goals may not be necessities but they help us achieve upward wealth mobility and give us a certain status in our social circle. 

Topic 7: Asset Allocation

When the market rises, people start investing and when markets fall people start selling. Think about it, if you are in a shopping mall, would you buy stuff at a discount or at full price.

 

Therefore, if you manage your emotions, your investment portfolio is bound to do better.

You need to divide your portfolio as growth and income.

Growth assets are used to grow your wealth more than the inflation but take a few years to reach that objective. Equity and Real estate are growth assets. An income asset is to produce income. For example, a fixed deposit with a bank. An income asset is not expected to beat inflation.

 

This risk profile helps you establish a broad range of growth and income. Now you might be wondering, if you are planning for a long-term goal say retirement and say you are conservative investor, why not invest in only equity or real estate. The answer to this would be ‘your behaviour will not allow you to stick to equity/real estate for long-term and in case the value falls, you may act in a way that would jeopardize long-term objective’.  

Topic 8: Investment options

Let’s explore our options and then we will fit these options into the wealth allocation framework.

 

Growth

 

Real estate and equity are prominent options within the growth category. Real estate requires huge money to be invested in one go and there are illiquidity issues. This does not mean real estate is not a good option but rather suitable to investors who already have a decent corpus. Remember that your primary home is not your investment and should be excluded from the analysis.

What about equity?

A stock represents ownership in a company. An empirical study suggests that this asset class provides higher returns if invested for the long run. 

 

Remember, Life Insurance Corporation (LIC) also invests in equity. Bonus amount in case of an insurance product would also depend upon how the underlying portfolio of equity has performed.

 

There are a few simple options for equity investment:

 

Direct: you invest in a single stock. If you do not have time to perform fundamental analysis, stay away from this way of investing.

 

A mutual fund is a pool of money from numerous investors who wish to save or make money just like you. Investing in a mutual fund can be a lot easier than buying and selling individual stocks on your own.

 

Exchange-Traded Funds (ETFs) invest in stocks that comprise an index. The proportion in which it will allocate money may be the same as individual stocks’ weight in the index. For example, a Nifty ETF will invest in 50 stocks comprising the Nifty, most likely in accordance with the weight of individual stocks in the index. Since the selection and weight is decided by the index itself, there is no active manager to manage your investments, hence management fees of ETFs are very low.

 

Income options

 

There are a variety of assets that are categorized as income assets. For example, public provident fund (PPF), National Savings Certificate (NSC), Provident Fund, fixed deposit, corporate bonds, government bonds and debt mutual funds. Additionally, we have a New Pension Scheme that gives you the option to combine growth and income.

 

Both income and growth assets have a place and should be evaluated within the wealth allocation framework.

 

Asset allocation is not a one-time exercise. You would regularly look at any changing needs or desires and incorporate the changes in your investment portfolio. However, if you think of your needs and bracket them across the above three categories, it will be a lot easier for you to think about what kind of investments to include in your portfolio.

Topic 9: Retirement fund

Retirement Planning is about ensuring that there is adequate income to meet the expenses in the retirement stage of an individual’s lifecycle.

 

There are a few things you need to know before we get into the calculation. One is living expense, that comes from cash flow analysis. The other when do you want to retire and the third is your life expectancy.

Topic 10: How much to have for your child?

Remember that child can get a loan for education but no one gives you a loan for retirement and that is why child education can very well be need or a want.

Topic 11: How much insurance cover you must have?

The same concept can be applied to understanding an appropriate insurance cover. I am referring here to a term insurance plan that is pure insurance cover.

Topic 12: How to select the right Mutual Funds?

There are thousands of different schemes from various mutual fund schemes and selecting the best ones can sometimes get hard.

Most folks ask friends and family or research popular online websites to get the top fund recommendations and invest in the top-rated funds.

 

Here is the way to decide on each category of equity mutual fund.

 

1. Performance  

The fund, which has performed well in one quarter, may not perform well in the next quarter. Look at the performance of at least 5 years or plus. Compare the performance with NIFTY 500 index, explain why.

2. Total expense ratio

Always prefer direct mutual fund over a regular mutual fund. All the funds are in both the categories but one is with brokerage and the other is no commission.

3. Fund manager tenure and experience

Fund managers play a very important role in the fund’s performance. Though managing a mutual fund is a process-oriented approach, the fund manager is still the ultimate decision-maker and their experience and viewpoint count for a lot. Look at a fund manager with 5 years or plus in a fund.

Real-life case example

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