Setting up a goal is something that no one does these days. I am asking you all to set a financial goal.
Every time I ask someone – Why are you investing? What is the purpose of your investment? 90% people will answer to grow my surplus money.
I have money lying in my bank account. I am just spending too much. I thought it was time to start investing.
My next question is ‘for what do you want to grow your money?’ Their answer is to become rich or help in a financial need or to travel. Travel is a more focused goal but becoming rich? Isn’t everyone working to become richer than what they are today?
In cases, where your goal is more focused and clear, you will be in a better position to achieve it than your investments where it is not.
When you know where you are going, you are halfway there.
I know it is extremely difficult to sit with a pen and paper and jot down your financial goals. However, the difficulty of the process does not reduce the importance of the same.
I have listed below a step by step process of identifying your goals, requirements, money that you need and the products into which you must invest to achieve your goals.
What do you want to achieve in life?
I am sure you have been asked this question by various people ‘What do you want to be when you grow up? Where do you see yourself in 5 years? What do you want to do in life?’ These are all your various goals that people want to know.
What are the things that require money to be achieved – i.e. financial goals?
Yes. All goals need money but all goals are not financial goals. Wanting a promotion at work, Best in your field, learn a new hobby or activity are all personal and professional goals which does not require too much investment or any investment of money from your end.
Owning a house, traveling to Europe, buying that car, your child’s post-graduation are some examples of goals which require a huge investment of money from your end and are called financial goals.
Hence, make a list of all your goals and from that highlight your financial goals.
Prioritise your goals – difference between Need and Wants?
It is very important to prioritise your goals based on its importance and requirement.
Needs are such things that you cannot do without and cannot be canceled, such as your child’s education or your first house.
Wants are things which you desire but can do without them such as a vacation, your second home etc.
Segregating your goals into needs and wants will help you prioritise them better. All the needs can them be numbered based on their importance followed by your wants.
How much money do I need today to achieve these goals?
Once you have made an entire list of your goals and sequenced them, you must identify what is the cost of achieving those goals. For example, if your goal is to buy a car, you must identify which car you want and how much would it cost. ‘I want to buy a car like I20 and it would cost me 7 lakhs INR today’ – this a well-defined financial goal.
Where you are estimating the cost of goal because you do not have an exact basis to calculate it, always consider the amount on the higher side.
By when should I achieve these goals?
The fact that it is a goal, it means it is futuristic and you do not have sufficient means to achieve it today. Hence, you must identify and apportion a realistic timeline towards your goal.
For example, I want to buy a car in next 2 years.
Adjust the Inflation
Given that goals are a futuristic, the current cost that we have associated to our goals will obviously increase in the future because of inflation. Identify the inflation rate towards your goal. The inflation rate is not the same for all types of goals; it varies depending upon the market conditions and the goal.
After knowing the inflation rate and the current cost, you will be able to compute the future value of your goal.
It is very important to identify the correct inflation rate. If you take a lower inflation rate your goal will cost you more than what you estimate and if you take a higher inflation rate, the future cost may scare or reduce your confidence to be able to achieve the goal.
Asset allocation based on the goal, cost, and tenure
Once you know your goal and its value, it is time to identify the investment products.
The tenure of your goals will help you to identify what asset class you must invest in and in what ratio.
This is a very general method of asset allocation. It may vary depending on your risk taking capacity and ability. Hence, it is important to analyze the same for oneself.
Portfolio Return Expectations
Return expectation from each class of the asset is as follows:
You will have to invest money in your goals based on the tenure and asset allocation. Each goal will not have one investment but may consist of many investments some in equity and others in debt. Hence, it is important to compute the return expectations for the entire portfolio, to be able to compute the exact amount you must invest to achieve your goals.
For example, my goal of buying a car is a mid-term goal, my asset allocation will be 40:60.
My portfolio return will be (40% * 8%) + (60% *12%) = 11.2%
How much money to invest?
This is the most crucial part, the entire computation of the above working will lead to identifying how much money you need to invest to achieve your goals.
There are various ways of investing but it is better to do it in a systematic manner. You can invest as a monthly fixed investment amount or invest annually with a fixed percentage of investment increasing per annum.
SIP – 7900 per month invested for 7 years will give you a return of 10,14,000 @11.2 %.
This method can be a bit complicated when followed step by step especially the last step of computing the actual amount that one needs to invest to achieve their respective goals. However, it is the most defined way of achieving your goals. There are many software used by us – financial advisors where the software does the same calculation for us. When you will sit with an honest financial advisor, the first thing that they will ask you is to define the goal. There is no plan without a goal and hence, such a working is extremely important for your financial planning.
Over a period of time Mutual funds have become a very popular investment vehicle in India. The reasons for the popularity of mutual funds among investors are many:
Qualified Professionals manage the Mutual Funds and attempt to maximise the returns and minimise the risk within the stated objectives of the Mutual Fund Scheme.
This is the biggest advantage of investing in a mutual fund, especially for a small investor. This ensures that the investor is not exposed to the risk of a single sector and is not dependent on the performance of one company.
An investor can get exposure to professionally managed Mutual Fund investments for as low as Rs. 500. They can get exposure to big tickets investments(like some Fixed income instruments) through Mutual Funds. Also, SEBI has capped the maximum amount that can be charged as an Expenses to the fund based on the fund size.
Mutual Fund Schemes held by an investor are very liquid. They can be redeemed at the NAV of the Scheme which is declared every day and the redemption proceeds are received by the investor in T+2 days i.e. within two days of the date of redemption.
Choice of schemes
An investors can make a choice from a large number of Schemes so that the investments match with his objectives and goals.
Within Schemes, investors are provided with a number of options like Growth Option, Dividend Option, Reinvestment Option, Systematic Investment Plan (SIP), Systematic Transfer Plan (STP), Systematic Withdrawal Plan (SWP), etc.
Mutual Funds have come out with a number of innovative products like Trigger facility, transfer of equity gains to a debt scheme, etc. to satisfy the needs of the investors.
This has increased the confidence of investors in the Mutual Fund Structure. Information is available to investors through fact sheets, offer documents, annual reports, periodic investment statements, etc. on a periodic basis.
Dividends received from equity schemes of Mutual Funds (i.e. schemes with equity exposure of more than 65%) are completely tax-free. Equity schemes held for more than one year do not attract any capital gains tax on redemption.
SEBI Regulations govern the mutual funds industry and protect the interest of investors. This also ensures transparency in the operating of the Mutual Fund.
Though very less compared to the advantages, Mutual Funds suffer from the following disadvantages:
(a) In case the manager does not perform well, the fund may give returns lower than the index.
(b) The investor has to pay a management fees and other expenses even if the fund gives negative returns. Returns are not guaranteed.
(c) Investors have no say in their portfolio as the same is managed by the AMC as per the scheme objectives and customisation for an individual investor is not possible.
Risk refers to uncertainty in returns. Debt instruments are considered less riskier than Equities because there is a lesser uncertainty in the returns one can expect from Debt Instruments. Never the less, following are the major risks are involved in investing in Debt Securities.
Fixed income securities such as bonds, debentures and money market instruments face interest-rate risk. Generally, when interest rates rise, prices of existing fixed income securities fall and when interest rates drop, prices of fixed income securities increase.
For example: If a Rs. 100 par value security offers 9% rate of return, and the prevailing rate of interest increases from 9% to 10%, the values of the security will fall below Rs. 100 because it offers a lower rate of return(9%) compared to the market return(10%). The extent of fall or rise in the prices depends on the existing coupon rate, time to maturity of the security and the quantum of increase or decrease in the interest rates.
In simple terms this means that the issuer of a debenture/bond or a money market instrument may default on interest payment or in paying back the principal amount on maturity. Even if no default occurs, the price of the security may go down if the credit rating of the issuer of the debt instrument goes down.
Investment in Government securities has zero Credit Risk as the Government is not expected to default on its obligations.
This refers to the ease with which a security can be sold at or near to its market value. Liquidity risk can be measured by the difference between the buy price (bid price) and the sell price (offer price) quoted by a dealer. Larger the difference, greater is the Liquidity Risk. Indian Debt market has a higher Liquidity risk compared to Global Debt market, because of low trading volumes in the Indian Debt market.
If interest rates fall, the coupon payments being received on fixed income securities will have to be re-invested at the lower prevailing interest rate. This is known as Reinvestment Risk.
For example: If you are receiving 9% coupon on a fixed income security, and the prevailing interest rates are 7.5%, the coupon payment received will have to be invested at the lower rate of 7.5%.
As zero coupon securities do not provide any periodic interest payments they do not have Reinvestment risk. However, they have a higher interest rate risk.
In turbulent times, gold has shown up as an effective hedge against equities in a portfolio. Though there are many ways in which one can exposure to gold, investing in Gold ETFs stand out because of its many advantages and convenience.
Gold ETF is an Exchange Traded Fund that aims to track the price of gold. Just like how equity shares of a company are bought and sold on the Stock Exchange, Gold ETFs can be bought and sold on the Stock Exchange at the prevailing market price of gold.
How to Purchase: To be able to purchase a Gold ETF, one needs to have a demat account and a broking account with any broker. Gold ETS are traded in units wherein one unit represents one gram of gold.
This means when you buy one unit of a Gold ETF, you are buying one gram of gold and that one unit(gram) of gold will be credited to your demat account. In case of some Gold ETFs, one unit can represent half a gram of gold. Just like equity shares, you will have to incur brokerage costs when you buy or sell Gold ETF units.
Taxation: If the units of Gold ETF are held for less than one year, then you will have to pay short-term capital gains on such sale. If the Gold ETFs are held for more than one year you can pay either at a 10% tax rate on the gains without indexation or a tax rate of 20% with indexation, whichever is lower.
GOLD ETFs in India: India has the following Gold ETFs as on date:
Gold ETFs are being traded in India since March 2007. Benchmark Asset Management Company Private Ltd. was the first to put in the proposal for gold ETF with the Securities and Exchange Board of India (SEBI). However, that is no longer offered on the exchange.
Advantages of Gold ETFs:
(a) An investor can purchase gold in small amounts as one unit of the ETF represents one gram. These small amounts can be accumulated over a period of time.
(b) As the gold purchased is credited to your the account, there are no hassles with respect to storage of gold purchased.
(c) Compared to the purchase of physical gold, there are no worries with respect to the quality of gold purchased.
(d) Gold can be bought and sold at the prevailing market prices with no deductions with respect to making or handling charges.
(e) Compared to physical gold which has to be held for more than three years, Gold ETFs qualify for Long Term Capital gains if held for more than one year.
Gold ETFs have become the mode of investment in recent times and have been growing at a rate of over 50%.
Exchange traded funds or ETFs (as commonly known), are the mutual funds that can be bought and sold on the exchange. They are both passive and active. However, in India, they are generally, passive mutual funds.
However, unlike Index Funds, an ETF is listed on the stock exchange and can be bought and sold through a broker. You will need to have a trading account and a demat account. Index Funds can be bought/sold only from/to the Mutual Fund.
ETFs, come with several advantages over the index funds.
Though ETFs have a lower cost, they involve additional costs in the form of opening a demat account and the brokerage costs that need to be paid when you buy and sell an ETF. Index Funds are a choice for investors who do not have a demat account.
Why Invest in ETFs
ETFs allow long-term passive investors to diversify their portfolio instantly as they invest in the basket of securities. For shorter-term investors, they provide liquidity as investors can trade intra-day at prices near to the net asset value.
Investors also resort to exploiting arbitrage opportunities between spot prices, futures and ETFs. It gives investors better control and flexibility to manage their investments. ETFs have found favour with Institutional Investors also as a substitute for investing in Futures.
India joined the ETF club in December 2001 with the launch of India’s first ETF ‘Nifty BeES’ (Nifty Benchmark Exchange-traded scheme) by Benchmark Mutual Fund, based on S&P CNX Nifty Index. Since then a number of ETFs have been launched tracking different indices. Of late, Gold ETFs have become very popular in India because of its obvious advantages.
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