Building Wealth. A beginner s guide to securing your financial future. Where should he start? Prepare to invest

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Building Wealth

A beginner’s guide to securing your financial future

Atul is 36 and works for a pharmaceutical company. He looked at his financial situation and realized he would not have enough money to achieve his family’s financial goals. He decided to rectify this situation by learning the language of wealth and undertaking good financial planning.

Where should he start?

Put your finances in order

Atul has spent most of his life working, but hardly any time on planning how to put his hard-earned money to work more effectively. How should he plan his financial life? There are few steps Atul needs to take before he starts investing.

Step 1: Review your overall financial profile  Set up a budget

Budgeting is a crucial part of your financial foundation. You should regularly monitor and control your income and expenses. If you can’t budget, then succeeding as an investor is difficult.

 Insure your health, life and assets

In today’s uncertain world, it is necessary to protect your family’s current lifestyle against events or expenses beyond your control. You should see an insurance professional to seek financial protection for medical expenses, your life, and any other important assets you might own.

 Income – Expenditure = Savings

It is critical to draw up a savings plan. Define a percentage of your take home salary that is suitable for you, and put that away every month. For example, put away 10% of your take home salary every month.

 Repay high cost loans

Paying credit card bills on time can save you more money in interest costs than what most investments can earn you. These loans should be behind you before you start building your investment portfolio.

Put your

finances in

order

Prepare to

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Prepare to invest

Atul has now reviewed his financial profile, has set up insurance, has drawn a budget and identified a savings plan. The next step is for him to prepare to invest. Contrary to what most people believe, the amount of money Atul earns and his age do NOT matter. Neither does he have to be a financial expert.

Types of financial instruments

Bank Fixed Deposits (FD)

What Benefits Drawbacks

 It is a financial instrument provided by Indian banks, which gives you a higher rate of interest than a regular savings account, until the given maturity date.

 Fixed Deposits with reputed banks regulated by the RBI are very secure.

 Investment in FD’s upto Rs 1,00,000 for 5 years are eligible for tax deductions under Section 80C of Income Tax Act. Therefore, it saves tax.

 The main criterion for an FD is that it cannot be withdrawn before maturity. For example, if you put Rs 1,000 into an FD for 3 years, at 10% interest, withdrawal of the money before 3 years will carry a penalty.

Set your investment goals

 What are you saving for? Use time frames to help you organize your goals and future plans.

 For example, if you have children, you will need to plan for their college education expenses.

 Identifying your goals will be helpful for you to understand where and how you should invest.

Understand your risk profile

 Depending on our income and needs, we all have different capacity for risk.

 Different risk tolerance, depending on our psychological make-up.

 Understand YOUR risk profile and plan accordingly.

Learn the different types of investments

 Various short-term and long-term investment options available.

 Each carries different amount of risk.

 Identify the combination of financial instruments that will help you achieve your financial goals.

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Post Office Savings Scheme

 The Post Office offers various schemes such as National Savings Certificates (NSC), National Savings

Scheme(NSS), Kisan Vikas Patra, Monthly Income Scheme and Recurring Deposit Scheme.

 POSS are popular because they typically yield a higher return than bank FDs. The monthly income plan could suit you if you have regular income needs.  It carries low risk, because it is a

government instrument.

 The interest earned is taxable unlike the PPF scheme.

Equity shares (Stocks)

 Stocks, shares or equity mean the same thing. Share refers to a little part in the ownership of a business concern.

 By buying a share in a company, the investor becomes part owner.

 The rate of growth could be more than the bank interest rate.

 Dividend: Cash reward given to share holders as part of the profit made by the company at the end of each financial year. The larger the units of your shareholding, the more money you receive at the end of each financial year.

 Price of shares move up or down responding to the forces of demand and supply.

 Therefore, there is a high risk involved with investing in shares. You could double your investment or lose the whole amount overnight.  Always move with caution

when investing in shares.

Mutual Funds

 Pool money from many investors to invest in different financial instruments.  Managed by a

professional investment manager who buys and sells securities for the most effective growth of the fund.

 Made up of different investments and therefore, lower your risk.

 It is a liquid instrument.  Reduce transaction costs for

investors due to the large buying and selling size.

 Although diversification reduces the amount of risk involves, it can also lead to dilution. For eg, if one stock doubles in value, the mutual fund won’t double, because the stock is just 1 small part of the mutual fund.

 The managers of mutual funds make all the buying and selling decisions, which leads to a loss of control for the investor.

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Public Provident Fund (PPF)

 Savings cum tax savings instrument and can be opened at designated post offices or designated Public Sector banks.  Also serves as a retirement

planning tool for those who do not have a structured pension plan covering them.

 Amount of deposit can be varied to suit the convenience of the account holders.

 Interest on deposits is completely tax free.  Deposits in PPF are

eligible for rebate under section 80C of Income Tax Act.

 Ideal for long term investment.

 Legal heir of PPF account holder cannot continue to hold the account after death.

 The maturity period of the account is 15 years. Premature closure of a PPF account is not possible, except in the case of death.

Bonds

 Governments or corporates issue bonds in order to raise money for various projects.

 Bonds have a fixed face value, which is the amount to be returned to the investor upon maturity of the bond.

 They have a specific maturity date.

 Investors receive interest

periodically, which is calculated as a certain percentage of the face value – known as a coupon payment.

 Tend to be more stable than stocks, and can therefore stabilize your portfolio

 Coupons payments are consistently distributed at regular intervals, and therefore provide consistent income.

 Interest rate on your bond is set when it is issued along with the amount that will be returned on maturity. If there is inflation during that time, the value of the money will decrease.

 Corporate bonds carry a risk of default, in case the company goes bankrupt.

Money Market Mutual Funds (MMMFs)

 They are particularly suited to the needs of small investors.

 They are specialized form of mutual funds which invest solely in money market instruments, which are short-term in nature.  Money market instruments are

forms of debt that mature in less than 1 year and are very liquid.  While investing in a MMMF, pay

attention to the interest rate being offered.

 One of the safest instruments as the investment is usually made in stable instruments issued by government, banks &

corporations.

 Money market instruments usually required large sums of money, but through a MMMF, smaller investors can invest.  It is a liquid instrument like

mutual funds

 They are only suitable for short-term investments.  They give low

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Start Investing Now!

Atul has now learnt about the different financial instruments available for him to invest in.

He now needs to take the final step of building his portfolio.

Power of compounding

1 year 3 years 5 years 10 years 20 years

Rs 1,000 at 8%

interest Rs 1,080 Rs 1,260 Rs 1,470 Rs 2,158 Rs 4,660

Typical allocation for a moderate risk profile Equity Shares – 10%

Mutual Funds – 30%

Bonds/Other debt instruments – 50% Post Office Scheme – 10%

Financial planning is not about financial expertise. All it needs is the right approach and discipline!

Goal: Diversity

 Portfolio consists of all your investments in stocks, bonds, mutual funds and other instruments.

 Invest in different instruments and different sectors of the economy – if one sector does poorly, the other investments will make up the difference.

 Diversified portfolio spreads the risk evenly.

Power of

Compounding

 Sooner you invest, greater the benefit of compound interest.  Even if you invest a small amount, but early on, you could make a

good return.

 The effects of compounding are demonstrated below.

Invest as per

your needs

 If you need cash in a year, opt for shorter term, low risk investments such as bank FDs or money market mutual funds.  If you have time on your side, invest in stock market, bonds, PPF