Financial Planning for the Young Professional - Part 2

As I start to write Part 2 of this 2 part series - Financial Planning for the Young Professional, the equity markets around the world are bleeding red and in India, the market seems to going lower everyday. The rupee is at an all time low, growth seems to be faltering, inflation refuses to go down and with the fiscal condition worsening, the finance minister is even talking of 'austerity measures'! This is also the week when Facebook went public with a record 100 million shares being traded in the first 4 minutes of its opening. But even this highly hyped IPO lost its sheen and investors saw it losing over 11% in the week that followed the IPO. With the people around the world losing faith in equity, even Facebook seems unable to hold its ground. People seem to be talking of a 'new normal' of a world of high energy prices, low growth and stagnant wages. In spite of this doom and gloom scenario, the golden rules of investing have not changed.

And in this article, I shall focus specifically on the investment aspect of financial planning. In Financial Planning for the Young Professional - Part 1, I spoke about insurance products and the objective of covering all insurance products (even those which claim to be investment products like ULIPs) is because of my firm belief that insurance and investing need to be kept separate because both have differing objectives.

1. Equity Investments:

Equity is my personal favourite investment vehicle. The advantages and disadvantages of equity investments are many. In the current economic scenario, espousing equity may seem a huge risk. There may not be any other class of investment which has lost investors so much money in the past 1 year as equity. Yet I would recommend investment in equity for any one who is serious about wealth building. If you decide to stay away from equity investments, you lose one of the best investment channels to create wealth. Equity is not for the short term investor. When you start investing in the short term, you expose yourself to one of the biggest risks which is associated with equity i.e. equity's extreme volatility. Take any time period over 5 years and look at the performance of equity. There is hardly any asset class which can match its returns. But never invest in equity to fund a short term goal. Equity is a long term investment instrument. Equity has just one rule - buy low and sell high. Yet this is the most difficult rule to follow. Today as I write this article, there are several good stocks which are available for cheap. But due to the overall gloomy atmosphere, no one wants to buy stocks. Warren Buffet, the man who built his staggering wealth solely through investments in the stock market once said - 'You don't need extraordinary intellect to succeed as an investor.The most important quality for an investor is temperament, not intellect. You need a temperament that neither derives great pleasure from being with the crowd or against the crowd".

Though there several ways through which you can invest in the stock market, I would just suggest these two methods alone since they are uncomplicated and straight forward:

( i ) Mutual Funds: A mutual fund is a financial product which pools in the money of several investors and has a professional fund manager who invests in equities (the stock market), bonds or even commodities. Investing in a Mutual Fund is pretty simple. You decide on a good mutual fund and submit a cheque. You can apply online or buy it from your bank or the Mutual Fund Company's office. Check this article on How to Select a Mutual Fund to know how to select a mutual fund. The article When to Redeem your Mutual Fund would also be useful as it guides you on mutual fund redemption. Click here to get an over view on Mutual Funds.

Investments in a Mutual Fund with a  3 year lock-in period (popularly known as ELSS - Equity Linked Savings Schemes) enables an investor to claim tax relief under section 80 C.

( ii ) Direct Investment in Equity: This is my preferred method of equity investment. But this method is not for everyone. Most people who have burnt their fingers in the market have invested directly in stocks based on improper research, 'hot tips' from brokerages or some friends or just plain bad timing. Please do not attempt to invest directly if you do not have the time to do your own research. It is not very difficult to do research on stocks but it requires a certain degree of patience and discipline to go through balance sheets, follow up on all news about a company and then decide on how much to allocate directly to stocks.

My preferred investment philosophy is the Value Investing Approach which looks at the fundamental valuations of a company/share. I would like to leave the readers with this quote again by Warren Buffet which pretty much sums up my investment approach - "Never count on making a good sale. Have the purchase price be so attractive that even a mediocre sale gives good results"

The government has come up with a new scheme called the Rajiv Gandhi Equity Savings Scheme, which provides for income tax deduction of 50 percent for those who invest Rs.50,000 in equity and whose annual income is less than Rs.10 lakh. There would be a lock-in period of 3 years for this scheme.

2. Fixed Income Investments:

Other Fixed Income Products are the Public Provident Fund, NSC (National Savings Certificate) and other Tax saving bonds by the government. My favourite among them is the Public Provident Fund. (Click on the link to read more about them).

There are a lot of operators out there in the market, offering very high rates of interest and as an astute investor you must stay away from such institutions. Click here to read on these operators and why you should stay away from them.

In addition to these Equity and Fixed Income Investments, you can also Invest in Gold and precious metals and in the real estate. I have purposely not included anything on real estate since it is a capital intensive investment requiring large amounts of capital. Compared to equity and fixed income instruments, real estate is poorly regulated thus requiring investors to be very smart and on their watch all the time.

How much do I allocate to Equity, Fixed Income and other assets?

This is the most common question that I have come across and possibly because there is no correct answer to this question. The right answer would be 'The asset allocation depends on your risk appetite and your goals'. I know of people who are totally paranoid of the markets and even a slight dip in the value of their investments gives them sleepless nights. If you are such a person then please stay away from equities/mutual funds and focus only on fixed income instruments. However if you understand that though in spite of some short term volatility, equity is a wonderful wealth making medium in the long term, perhaps you could follow this simple rule of thumb : Subtract your age from 80 (viz. your life expectancy). For eg. if you are 25 years old, then on subtracting 25 form 80, you get 55. Hence allocate 55% of your investments in equity. The remaining 45% you can allocate to fixed instruments. This not a hard and fast rule & a person with average risk appetite can go for this approach. If you want a more aggressive portfolio then you can follow the '100 formula' viz. to subtract your age form 100 & allocate that amount to equity/mutual funds. So in the above example an aggressive portfolio holder would have 75% of his/her investments in equity. Please note that I am only talking of investments here and not insurance. The amount you allocate for insurance premiums is based on your personal need.

As I conclude this article, I want to reiterate that the secret to successful investing is discipline. Like I wrote in Part 1 of this article, first make a plan and stay disciplined in following your investment plan, making minor tweaks as per your needs as the years go by. May all your dreams come true!