For all the wealth of knowledge out there on the stock markets, on investments, on personal finance, people are still generally lost when it comes to managing their own money. Personal finance is a topic you have to make time for. Not all of us can do it easily and that’s why you have financial advisors. These can be in the form of certified financial planners, relationship managers, wealth managers, or even your trusted Chartered Accountant. But even before you approach a professional for guidance, you must have your basics right. And no, I’m not talking about stuff like asset allocation, diversification, mutual funds, tax-free bonds, etc. I’m talking of even more basic stuff like these three things:
1. What is risk? Imagine losing all your money on one single day. Horrifying thought. Put it at one extreme. Then think of earning 4% interest in a savings bank account. Much safer thought (I know banks can go bust, but stay with me here). Put it another extreme. Now figure out where you are between these two extremes. That’s your risk appetite today. Risk defines return because there is high risk, low risk, high return, and low return. All asset classes will fall somewhere between those four. But first, you need to understand risk. It’s easy to say “I’m willing to lose all my money” when investing in equities – till you see your first market crash and see your investments wiped out. It doesn’t feel good. Be prepared.
2. What are savings and investments? You keep Rs1crore under a mattress and remove it after 10 years – it will still be Rs1crore (unless rats ate it up). Sure, it might not buy what it used to, but it’s still a crore. Savings are like that. If they’re not invested, they will remain the same in amount but inflation will reduce its value. At best, you’d get savings bank interest. Investments are different. The value of investments keep changing over time. When you buy an asset (gold, real estate, stocks, mutual funds, fixed deposit, etc.), that’s an investment for you. The money in your bank account left after your spend your salary is your savings. That savings when transferred to a fixed deposit, mutual fund, etc. becomes an investment. Assets generate returns, investments go up and down in value, that’s all part of the game. But a savings bank account doesn’t give you dividend, and stocks don’t give you a guaranteed rate of return. Understand the difference.
3. What is long and short term? You want to buy a house after ten years but you also want a foreign vacation once every three years. After all, it’s your money and you should enjoy what it buys. But, while your goals are predictable, the markets aren’t. You don’t start trading in markets as a novice to buy a house, just like you don’t invest in an equity mutual fund SIP to buy a mobile phone. Investments should match long and short term goals. That will help you align your risk and return. Following the above questions, you should now have an idea of how much risk you are willing to bear when deciding how much you want to invest for a period of time.
All of us want the highest, safest, return for the longest period of time. But investing isn’t that easy and life isn’t that simple. An investment involves a variety of risks and its value can go up or down over the long and short term. A tax-free Government bond that gives a fixed rate of 7% interest every year or an equity mutual fund SIP for a 10year period that could potentially (but not definitely) give you a 15% CAGR over the same period? Or just buying a house and forgetting about it forever? None of these questions have any simple replies. Don’t complicate things further by being ignorant about risk, return, and time in investing.
Anupam Gupta is a Chartered Accountant and has worked in equity research since 2000, first as an analyst and now as a consultant. He contributes to the Business Standard platform, Punditry, through his blog, Beyond Markets on markets & the economic horizons.
He tweets as @b50
