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A young Indian's guide to saving and investing
When you are young and have just started earning, savings are the last thing on your mind. What you earn is relatively small, and what you want to spend on, inevitably large, so where do savings fit into the picture? You think, savings can come later. Unfortunately that never happens.
In part one of a two part series, we talk about how young Indians can start the habit of saving and investing their money systematically and safely.
Start saving: Why now?
It is never too early to start saving. Start small, understand your monthly expenses and mentally allocate five to ten per cent of your income to savings. By treating savings as a necessary monthly expenditure, you will begin a healthy and sustainable life-long habit.
Starting now is important because the power of compounding is immense and often overlooked. A basic fixed deposit investment yields about 7 per cent a year, which invested over five years can give you a return of more than 40 per cent (significantly more than five times 7 per cent).
You earn interest on the money you invest growing your assets, and subsequently, every year, you are earning interest on a higher amount. The greater the time horizon, the greater the power of compounding.
Your growing savings will provide you economic freedom and independence when you are young -- a nest egg to build your dream house, start your business, or pursue any other crazy dream you have.
The author is the co-founder of Forefront Capital Management (http://www.forefrontcap.com), a specialised portfolio management services firm providing equity investments based on quantitative portfolio construction. She can be contacted at radhika.gupta@forefrontcap.com.
Investment options: bank or the stock market?
Savings accounts: Bank accounts are 'simple' and 'safe', but little more than that. Savings accounts return around 3 per cent and interest is taxed at the highest tax rates. If you have to invest in debt, there are many higher return alternatives almost as 'safe'.
Buying stocks on their own: Trading in the markets sounds exciting and the returns in good markets are tempting for anyone. You hear friends buying stocks and making huge returns based on a report they have read or a tip they have heard. What you don't hear is that investing in the markets is not about stock picking, but systematic analysis of a portfolio.
Trading a few stocks based on ungrounded facts creates an un--diversified portfolio with risks you may not fully understand. Investing in equities is a great idea but hold a portfolio that is professionally managed, thoughtfully sized and diversified across many stocks.Asset allocation: what do I hold?
Investing is not about a bank account vs. trading in the stock market, but a trade off between the returns you want to earn and the risk you want to take.
A good portfolio holds debt, equities, and other asset classes (commodities, real estate, etc.) because every asset class has a unique set of risk and return characteristics.
Understand what different asset classes can and cannot do for you as a young investor (see table).
What should you hold as a young investor?
Broadly, young investors are advised to hold 40 per cent to 60 per cent in equities, 20 per cent to 30 per cent in debt, and 0 to 15 per cent in other asset classes like real estate and commodities, adjusted for an individual's circumstances.
Young investors have the benefit of time and should take relatively higher risk than older investors, who need their capital more immediately.
Your options: specific products I should choose?
Fortunately or unfortunately, once you have made an asset allocation decision and want to choose individual investment products, the range of options is huge.
The good side is that there really is a product to suit everybody's needs; the bad side is that it is very hard to make a sensible and informed decision. Be wary of chasing returns or picking the 'best performing product of the week' because that product changes every week. What does not change and is critical to a good investment is:
Fund manager's profile: who is managing the investment and how qualified are they to do it? What is the manager telling me about the risk and return of this investment?
Investment cost: what are the costs and fees of investing, both one-time and ongoing?
Investment horizon: how often can I withdraw my money and what are the costs of doing so?
Tax implication: how much tax will I have to pay on any income from this investment?
Long term performance: how has this product done over a long horizon? Everybody can make money in favourable markets -- has it made money in unfavourable markets?
In the next part of this series, we will evaluate specific equity, debt, commodities and real estate products on these criteria and see what best fits into a young investor's investment plan. Till then start building a regular savings plan, read more about different asset classes, and think of an asset allocation that would work for you.
Remember, while not everyone needs to be a stock trader, understanding the risk and return of your investment options is a life skill. You are a young Indian whose earning potential is growing -- managing your income is as essential as earning it.
You work very hard -- make your money worker even harder than you.