Important Points to Keep in Mind during Investment Planning
Investment planning is one of the most important steps in investment process, both for new as well as seasoned investors. Before beginning the investment journey, one should clearly outline the objectives and goals one wants to achieve while investing. Most of the seasoned investors are already aware of the nuances, but few important concerns which new investors need to address are related to return expectation, risk appetite, liquidity, inflation and taxation. In this article, we will try to understand the implications of these variables on investment decision process.
Return Expectation and Risk Appetite
We invest in an asset because it has earning potential and earning will come in the form of returns. Different asset classes have different earning potential together with the risk attached to it. Thumb rule is “High Return High Risk” /“Low Return Low Risk”. In simple terms, what it means is, you need to invest in high risk assets if you want high returns and vice versa. Now the question is how to identify a correct mix of risk and return. Answer to this question lies in the historical risk and return attached to a particular asset class. This data is freely available and you just need to google it. It’s recommended to peg your figures around historical data so as to avoid disappointment in future. Remember, whatever may be your risk appetite; capital preservation is of paramount importance as this capital will be generating future returns for you.
Liquidity and Transaction Fees
While planning investment and choosing asset class, liquidity (how fast the asset can be exchanged with cash) aspect should be properly considered together with the transaction cost. For example, even though real estate/land is a high return asset class, it’s highly illiquid. It comes with a baggage of high transaction cost and due diligence issues. Asset class with high liquidity and low transaction costs is considered a better investment. Equity/gold ETF investment scores above property investment from liquidity perspective.
Inflation
This is the toughest enemy you would face while investment planning and asset allocation. Persistently high inflation (around 7%) now a days, has made savings deposit, fixed deposit and PPF investments highly unattractive. Returns in these investments are around 4% to 8% which barely covers inflation. At the end, you are gaining nothing out of these investments as your purchasing power remains the same. It’s recommended to place a part of your investment corpus in asset classes which act as hedge against inflation, like equities and gold. Investment option for Moderate investors, as it will mitigate risk of inflation up to a certain extent.
Tax Implication
No one can escape tax demon. If we know this reality, then it sounds prudent to take it into consideration while planning for investments. There are some asset classes which are tax exempt and for others, there are ways to invest so as to minimize tax burden. As, for example, equity as an asset class is not tax exempt, but if you invest for long term i.e. more than one year, your capital gains are tax exempt.
Conclusion
Investment planning points mentioned above should be properly addressed, as ignoring any of them will eat away your returns in future. Remember the famous saying “Prevention is better than cure”, it applies to investment planning too.
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If you don’t have any investment goals, why invest at all? If investing is something you want to do, then there is obviously a reason for it – you want to retire, you want to have the money for your children’s education or you want to afford the house of your dreams.
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Setting Investment Goals – The Details
If you don’t have any investment goals, why invest at all? If investing is something you want to do, then there is obviously a reason for it – you want to retire, you want to have the money for your children’s education or you want to afford the house of your dreams.
These goals are great, but to build a suitable investment portfolio you need to be more specific. Detailed goals will help you choose appropriate investment options and build a portfolio that is right for you. That’s why setting investment goals is so important.
Setting Investment Goals – The Details
You can begin the process of setting investment goals by jotting down some rough ideas of the more expensive things you want to accomplish or buy in your lifetime:
· I want to retire by age 50
· I want to buy my dream house when I’m 30-35
· I want to be able to pay at least half of my child’s college tuition
· I want to own an Audi R 8
The examples above are big, long-term goals – excellent reasons for investing your money. After writing them down, begin working on the details. Figure out the following for each goal:
· Deadline: when you expect to need the money
· Cost: the total amount you need to reach each goal. This can be the sum of all periodic payments, if that’s what you goal calls for (such as the case with college tuition)
· Already Saved: the amount already saved for each goal, if any
· Duration: length of the goal if it requires payments over time
Be as specific and accurate as possible. It’s OK if you can’t come up with exact figures – use your best estimates. It’s better to start working toward something, even if you are a little off, than to wait until you can better predict the future.
Investment Goal Example
Here is what one of your investment goals may look like:
· Goal: to pay half of my child’s college tuition
· Deadline: around August, 2023
· Cost: estimated at Rs. 32,00,000
· Already Saved: Rs.5,00,000
· Duration: will be paying college tuition over the course of 5 years
And that’s it! After setting investment goals, write them down so you can review and revise them later. Circumstances do change, and it’s important to update your investment goals accordingly. Once you are done setting investment goals, you are ready to move on to the next step – determining your risk tolerance. Read about it in the next installment of our Portfolio Planning Basics series.
