Thursday, March 20, 2014

New Investor?

Many times on personal finance forums,  I see that people ask: I am new to investments. Please suggest which MF should I invest into. People like me list few MFs from different categories like Large or Mid cap. Some noble souls like Ashal probe them on their goals, time frame, quantum of money. He asks few questions to get clear idea and then suggest them the strategy. Some people give answers to his questions while some get rude to him for asking questions. To me being rude is destructive behaviour. Imagine we going to a doctor for cure on a particular problem. Dr. asks us various questions to know what problems we face and what other symptoms may be. By the answers given, Dr. comes to the conclusion of the disease. Now, if we do not give answers to his question, can Dr. diagnose problem?


Photo credit: Flickr - Kevin Meredith


This post is for all those people who are new investors and eager to get going.
Let us start from the beginning:
  • First thing first: Insurance.
Before you jump to random amount for insurance, wait. Know the difference between term plan and rest other plans. Understand why term plan suits you or why it does not. Calculate your yearly expenses. Multiply that amount by 15 (thumb rule, sorry). You get a figure ‘X’ amount. Now add all your debt to this X amount. You can add anything and everything. But primarily add house and car loan.
Personal loan, unaccounted loan, loan from relatives, credit card outstanding, blah blah blah.. all can (should) be added to that X. Now you get another number ‘Y’. Round that figure to nearest value on higher side, example: if the figure is 78 lakhs, make it as 80 lakhs or 1 crore. This is the insurance amount you need. If you can afford endowment plan’s premium for such huge amount, great. If not, go for online term plans. Again, people ask: Can I buy a term plan which gives my money back at the end of tenure? Answer: yes, you can. However, compare premium amount for basic term plan and such money back term plans. My take: Why complicate things. Keep it simple. Besides, if I calculate average term plan amount, it comes to around 1.75 lakhs (7k*25 years). Now, if you get this 1.75 lakhs after 25 years, would it matter, especially if you pay higher premium for that, today. 7k was the premium for non-smoker male. Money back term plan can cost around 14k per year. Your take.
  • Now that you are sufficiently insured think on emergency funds.
I wrote a small post of emergency funds. Read it here. Initially, I thought it may help some people. However, I got some funny response. Read them too: here. My take: Build emergency fund first and then venture for investment. There is no other better option.
  • Now, analyse how much monthly amount you have for investment.
Redo budget (it is easy to tell you do budgeting but hard to do it, got clue? :( ). Cut down on unnecessary expenses if need be (ha ha ha). Get that figure for monthly investment.
  • Now, decide your equity to debt ratio. Simple? Hell, no.
This is really difficult. The ratio is calculated on the below aspects:
  • Short term goals: More the short term goals, less is the equity component.
  • Your age: More is your age, less is your equity percentage. Note: at every age you would need equity, just the ratio would vary.
  • How much is your loan amount: More the loans, more should be your debt allocation. This can be little tricky. More loans means more money is exhausted in EMIs. So you need more money for long term goals. For that you need to be in equity. However, equity means volatility. It needs good amount of patience and heart to see yourself in huge debts and your investment going down by 50%. If you have patience and heart, this point can be ignored.
  • Risk appetite: Even if you do not have any loan and still cannot withstand market volatility, you should increase your debt allocation.
Once you get the figure, invest some time to understand what investment instruments are there for debt and equity investments. But if you are going to take months to study, start 2 small SIPs. 1 SIP in bank RD and other in large cap equity MF or balanced MF. The SIP amount will vary on the debt to equity allocation ratio.
Once your are done with your homework on debt and equity allocation, just go for it. Start full fledge investments. Some are not comfortable with SIP and can follow manual transactions. Read more here.

Then we have 2 approach. And none of them is right or wrong.
First: Earmark each MF or RD with goal and invest; example: MF from X AMC is for daughter’s marriage after 17 years.
Second: Invest as much as you can in 3-4 MFs or FDs/RDs. As and when you need money, redeem. As and when you got money, invest. Remember about short term capital gains and exit loads. Preferably, do not redeem from MFs before 10-12 years. This gives your money sufficient time to grow.
  • Add PPF account in your portfolio.
This should be part of debt allocation. PPF is suggested not because it is good or great. Reason: it is highly illiquid in nature. You cannot remove money before 7th year. If you forget the just written line, you remove money in 16th year. So you get huge compounding advantage. Read more about PPF here.

  • Direct Equity:
If you are ready to learn more, read about PE ratio, market sentiments, profit statements or annual reports of company plunge into direct equity. Go slowly and start with small amounts. If you are not ready to learn here, do not worry. 3-4 MFs for 15 -20 years would be sufficient for your retirement too.
  • Read about family health insurance.
Take family floater plans. Nothing specific here. This segment is not very complicated and details are easily available. All players are same. All have cap on room rents, non inclusion of some medicines or creams and such funny exclusions. Can’t help here.
Many people are so concerned about tax saving in 80C that they buy ULIPs or NSC at eleventh hour. Remember, you can avail MF with tax benefit too. You have 1 lakh cap on 80C. In this, your PPF, insurance, PF, MFs all are covered. You do not need ULIP for tax saving.
Note: I am not saying ULIPs are bad. I am saying do not buy ULIPs just for tax saving. If you understand its functioning and happy over it, go. Personally, I do not understand much in it and hence I prefer to stay away.
Next question that investors face is: Should I continue my LIC policies? Answer: no direct answer available. Remember why you took it. Is your insurance need covered? If yes continue. If no, calculate if its returns excite you. If still no, surrender. If yes, continue. Read why I surrendered my LIC policies here.
Remember Subra’s advice: if you have all the basic products (like index fund, 3-4 good MFs, term plans, health insurance), you just need to say NO to most investment advisors. He tells us that if we do not understand any product and if RM is pushing you for it, ask questions till you understand completely. Read how I used his advice here.
Finally, if you do not want to go through all these learning, pay someone to do it for you. There are financial planners who can do it for you. But selecting them is another task. If you planner says any of the below things, he is obviously to be left alone:
  • Sir, I am CFP certified and hence I am the best.
  • ULIPs suit you more than endowment plans (or vice versa). Term plans are waste of money.
  • I can manage your MFs effectively. Even if it does not perform for single year, I switch it to some other MFs and give you the best returns.
  • Equity will give you 58% returns in next 3 years.
  • Long term MFs are for 3 years.
  • Lock in for tax saving MFs is for 3 years, now since the lock in period is completed, we need to redeem and invest somewhere.
There could be many but above are sufficient indicators. Read Pattu' latest post here.
FPs should be like Ashal. He will ask you uncomfortable questions and expect honest answers. He forces us to do the homework. This enables us to think and learn. This is priceless. I do not know if he does consultancy but you can connect and ask.
Note: I do not stand to gain anything from Ashal if you connect with him. You can approach any other CFP as well. I just admire Ashal for being such a knowledge database and still being very humble, helpful and noble soul.
Additional points:
Visit Pattu blog.
Read books like JagoInvstor
Visit Jagoinvester site and read as many articles as you can.
Read about creating a will.
Read what is Nike’s slogan.
Huffff … too much for new investor…….
P.S. 1: Above are the ideal steps to be followed. I did not follow them when I started but I want new investors to proceed in proper steps. Again, as usual, your choice.
P.S. 2: Waiting for Ashal’s comment. I hope my post does not qualify to be a financial porn post.

Check out the Part 2 here


8 comments:

  1. Dear Viren. I'm really amazed the way you put your thoughts clearly and the most important thing - KISS. Congrats.

    I'm afraid, due to my name appearing many a times in this post, people may think, some hidden agenda is there between us. :) But this does not discount the good points raised by you.

    Let's hope at least few people get energy from this post to implement the ACTION.

    Thanks

    Ashal

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    1. Thank you Ashal for such encouraging words.... Yes, you are right, lets hope at least some people ACT....

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  2. Wonderful and really useful articles....well done..

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    1. Thank you Info-hunter..... I am glad that you found the post useful :)

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  3. Out of my personal experience one more point on when to stay away from CFP. When a planner ask you to invest thru him in the funds advised by him ask him will it be DIRECT plan ? if he says no ask him the reason. If he says he cant get online feed from AMC;s to keep track of the investment simply STAY AWAY.

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    1. Yes, Chetan. I missed that.... It is correct... thank you.....

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