One of your financial goals should always be to invest money and build assets. This is one of the five key elements of personal finance. As we gradually progress in our professional careers, ideally our assets should also increase. Stop for a moment and analyze your assets column before we get into points to consider before investing!
We would ideally like to reach to a stage where these assets can in turn generate passive income which can be again invested to create more assets! Somewhat similar to above flowchart, and hence it’s important to know how to choose correct asset classes.
Your choices can be impacted by lot of factors and in this post we will talk about six key points you should consider before investing. Let’s get started!
Every investment should be linked to one of your goals. So, the first step is to identify your financial goals. Take a moment and write down all your short term and long term financial goals that you can think of. Your financial goals may be creating an emergency fund, purchasing a house or car, creating a corpus for your higher education, creating a fund for your marriage or child’s education, retirement fund or simply building wealth. If you don’t have a list yet, I suggest you better get started. In fact, I’d suggest you to write down not only your financial goals but your life goals as well!
Time is money!
Once you are clear with your financial goals, you will have an idea of how much time you have got to achieve them. This is the time horizon that you can stay invested for and knowing it will help you a lot in filtering out right asset classes or products for your investments.
Time is one powerful determinant of fate of your investments. It can help you minimize risks and maximize returns. Even risky investment options like stocks and mutual funds tend to balance out volatility and maximize returns when invested in for longer periods.
The asset class you chose would be majorly dependent on how much disposable capital (or savings) you have, to invest. This is one of the important factors which impacts or controls your choices. Even more important is that if you have the capital to invest in one go, or do you want to build it step by step with your monthly salary.
Protection of Capital
Once you have the capital, next factor that you must consider is protection of capital. There is a famous quote by investment tycoon Warren Buffet –
“Rule No. 1: Never lose money. Rule No. 2: Never forget rule No. 1.”
There can be two kinds of asset classes –
- Original investment or principal or capital is safe. For example, recurring deposits or fixed deposits with banks, but the returns that you can earn are also fixed and at the lower side.
- There is a risk of losing your original investment or principal or capital but there is a higher potential for earning returns. For example, stocks, mutual funds or investments in start-ups.
Ideally you would want to take minimum risk i.e. protect your capital and get maximum returns. This is possible if you have correct time horizon and know your risk profile! This leads us to next important factor which is Risk profiling.
A common notion is that risk and returns are usually inversely proportional, whether in investment or life! Going by this notion, you should be very clear with how much risk you can take and then be ready to take calculated risks.
Divide your capital in two parts, one that you want to be absolutely safe and other where you can take some risks. It can be a ratio of 60-40, 80-20 or 90-10 based on your individual situation. Remember a thumb rule, if you have a clear upcoming goal or requirement of money in near future, that much of your capital should always be in safe investments. For example, if you have a capital of Rs. 1,00,000 to invest today but you know that this money will be required after six months for your sister’s college fee, you need to park it in a safe instrument where your original capital is secure.
Last but not the least, you need to consider how much tax you will be paying on returns. For example, returns from a bank fixed deposit are taxed as per your tax bracket while returns from PPF are completely tax free and returns from mutual funds are tax free up to Rs. 1 Lakh per financial year as of now. Now depending on your goals, time horizon and risk profile you may choose correct asset class which has lowest tax implications.
In this post we discussed about key points to consider before investing. You can decide where to invest your money based on what are your goals, how long you can stay invested, how much capital you have, how much risk you can take and how much tax you would have to pay on returns! If you can find out answers to all these questions, you have taken the first step towards DIY! I’d suggest you take a pen and paper and write down answers to all these questions right now.
Your feedback, comments and questions are most welcome!