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Impact of Compounding – Why should you start your SIP now.

Compounding is also one of the reasons why you must invest as early in your life as possible, even if the amount that you are planning to invest is small.

SIP (Systematic Investment Plan) is the best way to achieve the same too.

My father was very keen on us starting to invest with our first income and so I started investing Rs. 5,000 per annum at the age of 25 and continued to invest till I was 30.  I was investing this money for a long term horizon. Majorly for my retirement, so I have decided that I shall not touch the money until I retire i.e. at the age of 65. Given that I have invested in equity mutual funds where the expected return is generally 15%.

I should make approximately 45 lakhs at the end of retirement.

Whereas, My friend Priya did not start investing until she was 31. but she continued to invest till she retired at the age of 65. Again she was looking at 30 years of investments and invested in equity mutual funds, earning 15% return.

Priya will also make 44 lakhs at the end of the retirement.

At the time of retirement, both of us will make approximately 45 lakhs. However, whose method of investing is better?

In the above case,

I have invested only Rs. 25,000 (Rs. 5,000 per annum for 5 years)  and Priya has invested Rs. 1.75 lakhs (Rs. 5,000 for 35 years)

Isn’t it obvious that my method of investing is far better than that of Priya?

Priya had to invest seven times the amount I had invested, just for starting five years later than me.

Even then, Priya earns a lakh lesser than me.

Tabular representation

ParticularsMyselfPriya
SIP amount             5,000                5,000
Start Age2531
Invested Till3065
Maturity DateAt age 65At age 65
Maturity Amount45 Lakhs44 Lakhs
Total Amount Invested          25,000          1,75,000
Invested for 5 years 35 years

Amazing isn’t it?

That is the power of compounding taking effect for the investor who started early.

And this is why you should start your SIP at the earliest. If you keep waiting to develop enough money or grow older, you will miss out on your opportunities.

Most Essential Factor for a Successful Investor

Scores of articles have been written on this topic, what does it take to be a Successful Investor. A quick search on Google will give you results which include Fundamental Analysis, Technical Analysis, Economic data Analysis, Understanding the business of company, Timing the markets, monitoring Currency movements, and the list goes on and on. Then, what is the Most Essential Factor for a Successful Investor?

DISCIPLINE.

This one word overrides all other factors.

Discipline to stick to one’s investment plan.

Discipline to continue to contribute for one’s goals.

Discipline to book profits and re-allocate based on one’s Asset Allocation.

DISCIPLINE PAYS OFF

Studies have shown that more than 90% of the returns earned by an investor can be explained by Asset Allocation. That means, right Asset Allocation (for example, Debt or Equity) is more important than the selection of the actual instrument (say an HDFC Fund scheme or a Reliance Fund scheme). And it requires DISCIPLINE to maintain the Asset Allocation as time passes and as markets fluctuate.

Investors reaped enormous profits when the markets reached new peaks in January, 2008. This was followed by the famed crash in September, 2008 all across the globe. This led to panic redemptions on part of many many investors. Unexpectedly, the markets recovered quickly to reach the 2008 highs in November, 2010.

Investors who stayed invested were the ones’ who reaped maximum returns on the systematic investments made in the dips. Investors who exited in 2008 out of panic have only themselves to blame for missing out on the rally.

Again, the longer you stay invested in the equity markets, lesser is the probability of getting negative returns. A study of the Sensex returns for the past 30 years have shown that, if you were invested in the index for any period of 14 years or more, there is zero probability of earning negative returns. As one of the Investment gurus rightly said, “Time in the market is more important than timing the market”.

Successful investors from around the world swear by only one thing…DISCIPLINE. A Financial Plan helps you initiate and maintain that Discipline.

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Risk Involved in Investing in Equities

As mentioned, Risk is the uncertainty involved in the expected returns. Risk associated with Equities are much higher compared to Debt instruments. So are the returns. This follows the universal principle, “Higher the Risk, Higher the Return”.

Market Risk

The biggest risk associated with Equities is Market Risk. Equity instruments are volatile and prone to price fluctuations on a daily basis due to changes in market conditions.

Financial Risk

This is the second biggest risk associated with investment in Equities. Disruption in the internal financial affairs of a company will have a direct impact on the share prices of the company and may cause a loss to the investor. A prime example of such an instance is the Satyam fiasco in the January 2009 or a recent example of management fights in SKS Microfinance.

 Investing Risks…there are a multitude of them.

Liquidity Risk

This refers to the ease with which a security can be sold at or near to its market value.

Securities, which are not quoted on the stock exchanges, are inherently illiquid in nature and carry a larger amount of liquidity risk in comparison to securities that are listed on the exchanges. While securities listed on the stock exchange carry lower liquidity risk, the ability to sell these investments at the market price is limited by the overall trading volume on the stock exchanges.

Settlement Risk

It is a risk that the counter party does not deliver the security purchased against cash paid for it or value in cash for the security sold is not received after the securities are delivered by us.

Such risk can be avoided by entering into transactions in the nature of delivery versus payment (DVP) or settlements via clearing houses where the Stock Exchange acts as the counter party to every transaction.

 Risks associated with investing in foreign securities

The biggest risk associated with investments in foreign securities is fluctuation in foreign exchange rates. If you invest in a US Stock which gives you 20% return over a period of time and the US Dollar depreciates by 10% during this period, your net return in domestic currency will be much lower than 10%.

Other risk involved include restriction on repatriation of capital and earnings under the exchange control regulations and transaction procedures in overseas market.

You will see that a some of the risks listed above also affect Debt Securities. It is very difficult to segregate risks which affect only one type of investment.

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What are the different funds in a ULIP and why to switch between them?

Most Insurers offer a wide range of funds to suite’s one’s investment objectives, risk profile and time horizons. Different funds have different risk profiles and thus, varied returns.

We have listed below some common types of funds that are available:

Sr. NoGeneral DescriptionNature of InvestmentsLevel of Risk
1.Equity FundsInvests in equity shares of the companies listed on the stock market. This may be further split into small-cap Equity, Mid-cap equity and Large-cap EquityHigh
2.Debt Funds/ Interest  Income FundsInvested in corporate bonds, government securities and other fixed income generating instrumentsMedium
3.Cash Funds/ Money Market FundsInvested in cash, fixed deposits or other money market instruments which are liquid.Low
4.Balanced FundsThey are a combination of Equity and Debt i.e. a balance between Equity and debt.Medium to high

The funds of a ULIP are similar to the various fund classification of a mutual fund. It is due to the basic nature of both the investment products. However, it is not that easy to switch between mutual funds. Refer our Article on how to switch between mutual funds.

ULIPs are favorable due to the option to switch between different funds as per our needs and requirements.  The primary objective of switching funds is to leverage from the funds performing well. If your funds in your portfolio are not performing well then the peers, you may choose this option.

There is a basic cost involved in switching of funds which depends on the ULIP that you own. Some ULIPS, allow one transfer free and anything beyond that has a fixed cost. Refer our Article – Various Charges associated with a ULIP.

Also, many people make use of switching to meet their goals and make the most of the tax benefit. You may refer to our Article —-

To ensure that you make the most of this option, you must keep a track of the funds’ performance to make an informed decision.

  • Asset Allocation: You must switch to re-balance your portfolio, to maintain your asset allocation or to make the most of a sudden change in the market condition. This change in market condition may also require you to review your asset allocation. As discussed for this purpose switching is cheaper than selling and re-investing mutual funds. 
  • Life stage Needs / goal-based approach: when a switch is required to achieve your goals set in mind, you must do the same using this option in ULIPS. For example, if you have invested for a 10-year long-term goal in an equity-based fund. Based on the rules of goal setting, from the 7th year, you should start switching your fund to a debt fund to not lose the gains made in an equity fund. Such a switch is cheaper and more convenient with a ULIP than with a Mutual Fund.

Since ULIPs are long-term market-linked plans, you should review and manage them appropriately to optimize your asset allocation, minimize the risk and maximize your returns. If you are not confident about managing it yourself, it does mean that you should lose the opportunity of growing your own wealth. You can always take advantage of the auto-manage options offered by the insurer or appoint a financial advisor who shall do the same for you.

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Choice of Investment Products

Have you been confused when deciding where to invest your hard earned savings? You are not alone because there are a sea of products available for you to put your savings in. We make an attempt to give you a snapshot of products below: I. EQUITIES (1) Direct Equities: Investment in shares of companies through the stock exchange. This includes both the cash and the Futures & Options segments. (2) Mutual Funds:Investment in over 1,500 Mutual funds which include the following categories; Large cap funds, Mid-cap funds, Sector Funds, Index Funds, Hybrid Funds(Debt plus Equity) and ETFs.

NEVER PUT ALL YOUR EGGS IN A SINGLE BASKET!

II A. DEBT INSTRUMENTS (1) PO Monthly Income Scheme(MIS): A deposit offered by the Post Offices(PO) which pays a monthly interest. Suited for retired individuals. (2) PO Recurring Deposit(RD): Another scheme from the Post Office which enables small periodic savings with as low as Rs. 10 a month. (3) Kisan Vikas Patra(KVP): Popular fixed income bonds which repay the principal and interest on maturity. (4) National Savings Certificate(NSC): Popular fixed income bonds which repay the principal and interest on maturity. (5) Bank Fixed Deposits: The most popular investment avenue in India. The deposits could bear a Fixed Rate or a Floating Rate of interest. Banks also offer Recurring Deposits. (6) Mutual Funds: Debt Mutual Funds score over deposits because of they are more tax efficient and more liquid. These include Income Funds, Monthly Income Plans and Liquid Funds. (7) Corporate Deposits: Apart from banks an investor can invest in deposits ofCorporates, NBFCs and other Financial institutions. These generally offer a higher rate of interest compared to bank deposits and have a higher risk. II B. Retirement Saving Avenues: (1) Senior Citizen Savings Scheme(SCSS): A government of India Scheme specially for retired individuals. (2) Public Provident Fund(PPF): The most popular tax saving scheme falling under the ‘EEE’ category of investments. (3) Employees Provident Fund(EPF): Mandatory contributions to the EPF required by law for all salaried employees result in this fund forming a part of every individuals’ portfolio. (4) New Pension Fund(NPS): Another ‘EEE’ category product, which helps one accumulate a corpus for his retirement days. (5) Annuities: The corpus accumulated for one’s retirement can be invested to earn monthly annuities to meet post retirement expenses. (6) Reverse Mortgage: A product recently introduced in India, it offers retired individuals monthly income against the security/mortgage of their house. II C. Government Bonds There are a number of securities issued by the Government of India available for investment based on their requirement: (1) RBI Bonds (2) State Government Bonds (3) NHAI/REC Bonds u/s 54EC for Capital Gains (4) NABARD Bonds u/s 80C (5) IIFCL Tax Free Bonds (6) 8% taxable Savings Bonds III. STRUCTURED PRODUCTS (1) Capital Protection with market participation Products: Generally restricted to the High Networth Individuals(HNIs), structured products come in different shapes and sizes. (2) Private Equity(PE) Funds: For the niche section of investors, these investments fall in the high risk high return category. IV. REAL ESTATE (1) Direct Investment: This involves buying physical residential and commercial properties including land. (2) Real Estate Funds: Just like Mutual Funds, real estate funds pool in the investors money and invest in real estate properties. This scores over direct investment because of lower transaction costs and professional management of the fund. (3) Real Estate Investment Trusts(REITs): A security that sells like a stock on the stock exchange and invests in real estate directly, either through properties or mortgages. Such securities are not yet available in India. V. COMMODITIES (1) Gold ETFs: The most popular and easiest route to gain exposure to investments in gold. (2) Direct Investments: Just like the direct equity route, one can get exposure to commodities both in the cash or Futures & Options market. VI. FOREX The largest market in the world in terms of volume, this is an investment product which is not yet popular among the retail investors in India.

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