Eleven things you should know before investing


Investing can seem daunting to many. We round up a few pointers to help you along the way

By: Sayantani Kar and Aishwarya Agarwal

A brilliant mind is no guarantee for great returns on investments. Just ask Sir Isaac Newton and Albert Einstein. As anecdotes go, two of mankind’s most gifted minds did not do too well at the financial markets.

Einstein lost a chunk of his Nobel prize money on bad bond instruments, while Newton suffered so dismally holding stocks of the South Sea Company, whose bubble burst in the 1700s, that he said, “I can calculate the movement of the stars, but not the madness of men.”

What Newton discovered the hard way, you can master with these 11 pointers before investing.

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A savvy thumb-rule

The budgeting rule of 50:20:30 can help set a pattern for savings and investments early in one’s life. We should spend 50 percent of our monthly income in essentials, daily expenses and utilities. Twenty percent of the remaining should go towards financial priorities such as savings and investments and the rest 30 percent should be used for discretionary expenditure on lifestyle.

Know your (financial) self

We can start investing smart once we know ourselves better. All-encompassing as it reads, in the world of investment, this would mean a few things, as shown in the infographic below, all leading up to an understanding of your risk tolerance.

We would have to understand our net worth to realise how much we can invest further.

Our goals in life would bring forth the time we would have for investing. This would dictate where we put our money and how much. Long term goals can encourage riskier investments which would give higher returns but fluctuations would have to be waited out. Short term goals would need more stable returns but which can be easily made liquid (no lock-in).

Having a sum in mind helps set the stage. When investing, if we could factor inflation and then look at the expected rate of return on investment, it would stand us in good stead for building a realistic corpus.

These would lead you to understand how risk averse you are. We must also remember to account for our dependents and our age). Risk in investing means the chance of losing one’s money. At times, it could also mean erosion of our principal. However, understanding how much we can afford to let go and for how long (while we wait to earn it back), will give us the ability to pick our investments wisely.

For most of us, if we can stay invested for long, then we are better able to stomach an investment promising high returns but likely to go through fluctuations as the returns would compound, but with time.

Both scientists were unwilling to wait it out and chose to cut their losses.

Diversify your assets

One way to play it safe is by starting to invest in products requiring a low initial investment, such as in fixed income schemes, small savings schemes (or even fixed deposits, if you will) and if keen on more liquid equities, then through SIPs in ETFs. But asset diversification will be required if we want to progress in our investment journeys.

Goal-based division of investments are the best way to go about it. So, we have to choose a separate ratio of assets (asset allocation) for our wealth creation goals (for retirement, or long-term objectives) than that for short-to-medium term targets.

Lump sum vs SIP

A lump sum investment, often made in exchange-traded funds (ETFs) or mutual funds (MFs) mean a one-time investment. It is advisable if there is a large disposable amount at hand and also a high risk tolerance.

A systematic investment plan (SIP), on the other hand, lets us put a fixed amount each month instead of a large sum at the beginning. It does not need us to time our entries with such investments like we would have if we went all in. SIPs have been known to earn higher 5 year-plus returns compared to lump sum investments. With a SIP, only a portion of our principal gets beaten by volatility. It also helps to reduce our unit cost of buying over time due to rupee cost averaging.

Direct mutual fund vs regular mutual fund

Direct and regular are the kind of plans that MFs come in. They are run by the same provider or asset management company (AMC). The former, allowed by the Securities and Exchange Board of India (SEBI) in January, 2013, lets us bypass a distributor and saves us the deduction of a trailing commissions paid to one as distribution expenses or transaction fee by the AMC for regular plans. As a result, an additional saving accrues  to our investment sum in direct plans, getting us ~1 percent higher return annually than corresponding regular MFs. Although 1 percent might seem small, it becomes a sizeable sum when compounded over many years and accrued over time.

In regular MFs, an investment of three years would add a trailing commission of 1 percent each year!

Gold but not gold

Gold as part of our asset diversification can be a good bet. Rather than lock up our money in gold jewellery, it pays to invest in gold ETFs, gold bonds, gold bars (high on purity), gold MFs. Gold can safeguard us from the Indian rupee’s depreciation that affects money markets.

Discount broker vs full-service brokers

The table below delineates the key differences:-

Full-service brokerDiscount broker
Charge a commission on executing each trade; value a percentage (0.3-0.5%) of the tradeAn annual fee for executing equity delivery, and charge fixed amounts for intraday/futures/options; this often costs less than full-service brokers
Provides a trading platform along with detailed and frequent investment adviceMostly just a fast, robust trading platform
Ideal for those looking for advice and guidance in investmentsSuitable for those who conduct research on their own and/or have a financial advisor
Offer a wider range of services including investment banking, MFs, insurance etc.Mostly offer stocks, commodities trading
Examples include Motilal Oswal, Angel Broking, private banks’ broking arms etc.Examples are Zerodha, Upstox, SAS Online etc.

Tech to the rescue

Financial technology has advanced in leaps and bounds and given us the robo-advisor. These digital platforms, mostly in the form of apps, can get a first-time investor on the path of smart investing. These quickly gather the relevant financial information from clients such as their risk appetite and net worth, and automatically tailor advice to invest in assets. Some tie up with brokers to help execute the clients’ wish. Robo-advisors are algorithm-powered and work around the bias often found in human advice that include fear and greed. If only, the scientists had recourse to these.

For some instruments such as ETFs, we would need a demat account and can then go on to use such apps.

Scan what you have

Just as we go for our annual health checkups as we age, the life of an investor should also be marked by periodic stock-taking. Here, too, technology in the garb of online trackers and money management sites come in handy. Reviewing and revising our investments help us in the critical task of re-dividing our funds into assets for diversification. But it is a sure shot way of keeping our eye on our financial targets.

This would require us to learn more about our investments and the assets we are comfortable with.

It pays to be careful

Erring on the side of caution is perhaps one of the sturdiest advice in investing. If an investment product looks too good to be true, it probably is. That said, rather than keep our risk appetite down, we should be cautious about the less obvious traps in this world. Reading documents and their fine print before signing them and committing money, no matter how trustworthy the broker, guarding digital financial identities including passwords and PINs, and learning of ways of redressal amid rampant phishing and skimming attacks will arm us with the confidence needed to take the next step.

The world of taxes

Investing in India allows you various ways to get tax exemptions. There are various sections in our tax filing which lets us save, from active investments, health insurance to charitable donations (albeit not a financial investment, but a social one).

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