The money you earn is partly spent and rest is invested for meeting future goals. This is called investment.
You need to invest to:
i.Earn return on your idle resources
ii.Generate a specified sum of money for a specific goal in life
iii.Make a provision for an uncertain future
iv.To beat inflation
The sooner you start investing the better. By investing early you allow your investments more time to grow, whereby the concept of compounding (we shall see it later) increases your income, by accumulating your principal and the interest or dividend earned on it, year after year.
Three golden rules for all investors are:
iii.Invest for long term
You may invest in:
Physical assets like real estate, gold, art etc. and/ or
Financial assets such as FD`s with banks, small saving instruments with post offices, insurance/ provident/ pension fund etc. or securities market related instruments like shares, bonds and debentures etc.
Following are the basic principles, which you (an investor) should use in creating their investment strategy:
i.Harness the power of compounding
iii.Have realistic expectations
Goal setting is converting your personal goals into mathematical numbers. It means identifying your financial capabilities, setting smart and realistic goals based on your dreams and aspirations and achieving them through a comprehensive plan.
Goals should be SMART, which is specific, measurable, actionable, realistic and tracked.
A budget is a systematic plan for the money you have and the money you will eventually spend.
It is a statement, which list down your various sources of income and expenses. It tells how much money you have left for saving and investing after meeting all your regular expenses.
It is also called the statement of financial condition, it is a summary of your assets, liabilities, and owners' equity.
The market value of all your assets (including cash) less your total liabilities. It is often used as an underwriting guideline to indicate your creditworthiness and financial strength.
Net Worth is sum total of all your assets minus sum total of your liabilities.
Different categories of investments are sometimes described as asset classes. The three main asset classes are equities (stocks), fixed-income (bonds), cash equivalents (money market instruments), real estate and commodities.
An investment strategy that can reduce or spread market risk by combining a several categories of investments, such as stocks, bonds, real estate, commodities which are unlikely to move in the same direction at the same time.
Asset allocation is the process of creating an optimal investment mix, bearing in mind risk profile and return objectives. Asset allocation ensures that a portfolio diversifies or spreads the overall risk across investments. A balanced portfolio should include a mix of equities, debt investments, commodities (such as gold), and real estate. How much capital one will invest in each investment class will depend upon his risk profile.
One should understand the simple principle of finance that an investment can be rapid if investment proceeds are re-invested. If interest incomes are re-invested and allowed to earn at the same rates, the rates are enhanced over a period of time. This is called compounding. For maximum benefits investors should allow their investments to compound.
For eg. If you invest Rs 1000 per month continuously for next 10, 20, 30, 40 and 50 years and allow it earn an interest @12%. Your actual sum of money at the end of these period would be as follows:
|Amount invested per month||No. of years||Compounded rate of interest||Total Amount at the end of period|
This is said to be the power of compounding.
The act of insuring, or assuring, against loss or damage by a contingent event; In legal terms, it is a contract whereby, for a stipulated consideration, called premium, one party undertakes to indemnify or guarantee another against loss by certain specified risks by certain specified risks.
Life insurance is always a protection against an unfortunate event. A life insurance policy can relieve your family of financial stress in case of any unfortunate happening. It will provide financial security to your family members and will relieve them of all the liabilities you might have left behind.
Gold is an old asset class in which people invest. It is a hedge against inflation and provides an extremely good liquidity in an unforeseen event like war. However, since last 25 years it has under-performed bank deposits.
A rate of increase in the general price level of all goods and services that results in a decline in the purchasing power of money is called the rate of inflation. It reduces the value of money over the period of time.
The real rate of return is actual rate of return on investments minus current rate of inflation.
Estate planning is a process designed to help you manage and preserve your assets while you are alive, and to conserve and control their distribution after your death according to your goals and objectives. But what estate planning means to you specifically depends on who you are. Your age, health, wealth, lifestyle, life stage, goals, and many other factors determine your particular estate planning needs.
Risk taking capacity depends upon several factors such as investment objectives, personality, investment time frame, age, income, number of dependents, how much wealth you have accumulated, and so on.
Your risk tolerance is the degree of uncertainty you can handle when there is a negative change in your portfolio�s value; in other words, how you react when your investments make a loss.
There is a subtle difference between risk tolerance and risk taking capacity. Risk tolerance lies in your mind and tells you how much risk you WANT to take whereas risk-taking capacity is the amount of risk you SHOULD take keeping in mind the factors discussed above.
Whether you are an active or passive investor. You have an obligation to be informed about economic and financial conditions. Active investors must certainly monitor general business affairs, plus specific news that has an impact on their investment. While passive investors may not wish to be so closely tied to the ebb and flow of daily, weekly or monthly information, they must have an overall understanding of what is happening to their money, what their objectives are, who is accountable to them, how decisions are made
Mutual Fund is essentially a mechanism of pooling together the savings of a large number of small investors for collective investment, with an avowed objective of attractive yields and capital appreciation, holding the safety and liquidity as prime parameters.
Systematic Investment Plan is a method of investing into the fund of investor�s choice at regular intervals over defined time frame. This helps the investor to invest monthly, quarterly etc.
Since a constant sum is invested regularly, the investor is able to get more number of units in the falling market and fewer units when the market is booming. This helps the investor to smoothen out the market fluctuations and the investment will be at a low cost over a period. This strategy is called ``Rupee Cost Averaging``.
When you invest the same amount in a fund at regular intervals over time, you buy more units when the price is lower. Thus, you would reduce your average cost per share or per unit over time. This strategy is called 'rupee cost averaging'. With a sensible and long-term investment approach, rupee cost averaging can smooth out the market's ups and downs and reduce the risks of investing in volatile markets.
An investing strategy that works much like Rupee cost averaging (DCA) in terms of steady monthly contributions, but differs in its approach to the amount of contribution made each month. In value averaging, you (an investor) sets a target growth rate or amount on your asset base or portfolio each month, and then adjusts the next month's contribution according to the relative gain or shortfall made on the original asset base.
For eg: Suppose that today your portfolio is worth Rs 5,000 and your goal for the portfolio is to increase by Rs 500 every month. If, in a month's time, the assets have grown to Rs 5200, you will fund the account with Rs 300 (Rs 5000 � Rs 5200) worth of assets. In the following month, the goal would be to have an account holding of Rs 6000. This pattern continues to be repeated in the following month.
With the method, you (an investor) contribute to your portfolios in such a way that the portfolios balance increases by a set amount, regardless of market fluctuations. As a result, in periods of market declines, you contribute more, while in periods of market climbs, you contribute less. In contrast to Rupee cost averaging, which mandates that a fixed amount of money be invested at each period, the value averaging investor may actually be required to withdraw from the portfolio in some periods.
Value averaging incorporates one crucial piece of information that is missing in Rupee cost averaging � the expected rate of return of your investment.
Before making any investment, you must ensure to:
1. Obtain written documents explaining the investment
2. Read and understand such documents
3. Verify the legitimacy of the investment
4. Find out the costs and benefits associated with the investments
5. Assess the risk-return profile of the investment
6. Know the liquidity and safety aspects of the investment
7. Ascertain if it is appropriate for your specific goals
8. Compare these details with other investment opportunities available
9. Examine if it fits in with other investments you are considering or you have already made
10. Deal only through an authorized intermediary
11. Seek all clarifications about the intermediary and the investment
12. Explore the options available to you if something were to go wrong, and then, if satisfied, make the investment.
A commonly used phrase in personal finance and retirement planning literature that means to automatically route your specified savings contribution from each paycheck at the time it is received. When you set down to pay your bills, the first check you write should be to yourself. Decide on an amount you can commit to for at least six months and immediately pay that ``bill`` by depositing the money into your brokerage, mutual fund, or retirement accounts.
Because the savings contributions are automatically routed from each paycheck to your investment account, this process is said to be ``paying yourself first``, or before you begin paying your monthly living expenses and making discretionary purchases.
One must do this even if he cannot afford it! Then, pay your other bills as usual. If you find that you do not have enough money to cover all the expenses, write down the amount you are short and then find away to raise the money. For this you may have to cut down your monthly expenditure, cut down your electricity, telephone and other bills or work a few extra hours, or cancel your magazine subscriptions, to make it happen.
Debt trap refers to a situation where investment income is insufficient to meet even the interest on debt and hence repayment remains a non-achievable one. Sometimes it may so happen that in order to pay the interest on the first loan you take another loan, which increases your present amount of debt.
It�s a trap because debt enslaves you. When you go into debt, you lose your freedom.