Many young professionals with significant earnings still find themselves in a dilemma at the end of every month. For instance, Mr.Azeem, a team Leader lat a large telecom software firm, complains, “I’m always out of cash by month end.” His friend Prakash suggested that he try the lottery, and another colleague suggested betting on stock market trades. Azeem then admitted, “I’m not good at betting/speculation. Instead, I’ll wait for the next onsite opportunity to make good money and buy a Mercedes…then I’ll have sufficient money forever.”
Wow! Good thinking by Azeem, right? No, this is an absolutely wrong and flawed approach. Why? Azeem seems to be a good day dreamer. He is hardly able to save a few thousand every month and has no savings or investments for a rainy day. How can he expect to become rich and have sufficient money forever? His idea to buy a Mercedes is also not encouraging because this reduces his saving ability. The idea of hitting a jackpot that solves your problems is wishful thinking or probably a nice excuse to postpone or avoid current problems. Instead, Azeem should work on improving his financial situation.
Steps to Investing
Taking the first few steps and being consistent and steady in moving forward is important. You should first get your basics correct and gradually move to higher levels of investing as your savings improve. Before investing, you need to take various steps and go through certain processes, some of which I’ll list here.
- Prepare and track a monthly budget of incomes and expenses
- Reduce or eliminate the extra expenses to boost savings
- Assess your average gross savings every month
- Keep three to six months’ worth expenses in a bank account or partly in cash for short- term contingencies or emergencies (called contingency funds*). Building up contingency funds may take a few months, but please do not skip this step. The efforts that you make here will be worthwhile
- Assess your average net savings (i.e., gross savings minus contingency funds)
- Start investing your net savings gradually (part by part) in different asset classes such as equity, debt, gold, and
Note: These steps have to be implemented every month to enable you to build your investments and wealth on a regular basis.
* Contingency Fund: These funds are part of your savings that are kept separately for emergencies, such as a sudden medical problem, accidents, damage to assets or property, festive occasions, or celebrations.
Benefits of Investing and Personal Goals
In simple terms, investing can provide two-fold benefits: additional income or earnings and capital appreciation (in value of investment). For instance, if you invest in stocks you benefit in two ways:
- Regular income in the form of dividends
- Increase in the value of stocks (capital appreciation)
When you plan your investments, you must have a goal in mind for what you want to achieve from the investments. These goals can be personal, which need to be converted into monetary terms. For example, let’s say you are planning for higher education for your daughter 10 years from now and expect it to cost Rs.20 lakhs. To achieve this, goal you need to have a target to have Rs.20 lakhs within nine years through the right mix of investments.
The planning process is quite detailed and beyond the scope of this write-up. However, for best results, financial experts advise investors to move to safer avenues as they get closer to their target amount.
Choice of Asset Classes
Now that you understand the importance of savings and goals, it is time that you learn about various asset classes, including the following:
- Equity (stocks, mutual funds, ETFs)
- Debt (government securities, bonds, debentures, fixed deposits)
- Gold (jewelry, gold coins, gold ETFs, gold funds of funds, gold mining funds)
- Real estate
Financial advisers generally suggest that individuals invest more in equity at younger age, to give them time on their side to take risks and build wealth. For instance, a 30-year-old can invest up to 70% in equities.
The percentage of equity allocation can be calculated using the formula 100–age: so, 25-year- old can invest up to 75% (100–25) in equities, whereas a 65-year-old can invest up to 35% in stocks (100–65). As you get older, the equity portion of your investment pie becomes smaller to minimize risks. However, these are only guidelines and not sacrosanct, and each individual is free to decide based on his/her personal requirements and circumstances.
Let’s look at various parameters that investors review when making decisions on whether to invest in equities:
Misconceptions about Investment
A colleague, Mr.Prabhu, used to ask me for help by suggesting some investments. One day, as a few colleagues were discussing investment-related information such as stocks, gold prices, he came up to me and asked if I could spare some time to advise him. Our private conversation went like this:
We had a few more conversations and I had to disappoint Prabhu and dampen his enthusiasm, but I frankly did not want to give him false hope. Further, I did not want to encourage him to take a step that would turn out to be risky and dangerous. I just made him understand that his points are perfect in theory and on paper. However, in practice, a lot of market variables and uncertainties exist that affect returns. In real life, investing involves a systematic process and a lot of trial and error and judgemental mistakes.
In real life, one cannot predict that stock X at Rs.100 and will go to Rs.250 in three years. Even if such estimates by experts came true perfectly, then most people would become stock traders by profession. Can you learn to drive a car just by reading a book? No, not really, because a manual or book only provides some basic knowledge; hands-on driving experience can help you get a license to drive. Hands-on experience also helps you learn about handling different features of a car, such as steering, brake, accelerator, indicators, headlights, and gears.
Most people think that investing can create that one big jackpot that will make them rich overnight, which is too good to be true. Therefore, they believe that if they do one deal and risk Rs.1 lakh, they then can turn it into Rs.10 lakh within a few months, and become Mr. Richie Rich.
Investment – The Slow and Steady Marathon
Unfortunately, investing is not like betting or gambling. It is a long-term commitment to build wealth brick by brick. Would you believe someone who promises to build a house on your land within a month? No, because doing so is not possible. Investing is a process of diverting your savings toward productive assets that will generate income or capital gains over a period. As you invest more and more, your portfolio, which was a few thousand rupees, could reach a million rupees in a few years.
However, this growth requires meticulous efforts, patience, and the ability to control one’s personal finances. Do not be tempted by watching traders or those who made a million in six months. Instead, focus on your own financial situation and have you own plan of action. In simple terms, the lessons from the old tale of “the tortoise and the hare” applies to investing—a marathon in which the slow and steady win.
Get rid of all of your misconceptions about investing and look at it as a learning path or long-term path for building sustainable wealth for your family. If you are a disciplined saver and investor, you will definitely become a successful investor who can pass on not only wealth, property, and a legacy but also knowledge and experience, to the next generation.