INVEST SIMPLY THROUGH FOUR BASKETS APPROACH

It becomes very difficult for a non-financial background person to have a detailed financial plan and follow it systematically. So how can we make the investing things simple? In this post we will try to simplify the investment process in a lay man’s way.

Firstly we have to figure out our income, expenses and savings. We should also identify our primary and secondary goals which we want to achieve. We can divide our total income into four baskets based on the priorities of the need for the money.

The first part of the savings should go for immediate requirements and emergency purpose; like if we lose job how are we going to survive and meet our daily expenses. We can keep 3-6 months expenditure in this basket. The money saved for this purpose can be invested in liquid/ultra-short term mutual funds or may be in short maturity fixed Deposits. The main objective of this basket is to get the money as and when required therefore liquidity of this investment is of paramount importance. Now, many app-based systems for investing and redeeming money from liquid funds have been introduced which can move funds back and forth with ease and speed. They offer almost double the returns of savings accounts while being potentially much more tax-efficient.

The second basket of savings could be statutory or forced savings. Under Section 80C government gives us exemption for savings. Certain instruments are qualified for this savings which includes PPF, Insurance, ELSS, NSC etc. This type of savings helps us in two ways: first it reduces our income tax outflow as well as it forces us to save for a minimum period of 3-5 years. Some of these investment like PPF, ELLS are tax free at the time of maturity also hence gives full benefits of the savings. We can save upto Rs. 1.50 lakhs under 80C and additional Rs. 50,000 in NPS under section 80CCD. This saving can be used for short to medium purposes and can also be recycled for future tax saving purposes. Apart from this we should also have proper mediclaim polices which are also tax exempted for self, family and parents under section 80D.

The third basket of our savings could be based on our specific medium term goals. These goals/expenses can be figured out with more certainty as they are in near future say 3-5 years’ time. For example we would like to buy a house in next five years and need to put down an initial payment. Or we need a new car in three years, as the existing one will be pretty old by that time. We can separate these needs from the long term needs as they are more predictable and have shorter time period as compared to longer ones. This kind of savings can be put into balanced or hybrid mutual funds which are more tax efficient and have better returns comparatively. They are less volatile, and have a lower tax outgo than bank FDs.

The fourth and last basket is the one where we would be investing for a longer time horizon for example eight to ten years and more. These savings could be for our own old age requirements, or for kids education/ marriage etc. These investments would be based on our age and specific needs. Since these investments are for longer durations they can be kept in equity based investments options i.e. equity mutual funds. Even though equity funds can be volatile in the short term, they are the only asset class which can provide good enough returns in the long term to beat inflation and provide substantial returns. The income earned from equity mutual funds is fully tax free so gives us the maximum benefits without any cut.

To achieve anything we first need to know our goal, similarly to achieve a financial freedom we must know our specific goals and plan accordingly. For a starter, the four basket approach could be a good beginning in this path of financial freedom.

What to do when Market is continuously rising

This week BSE Sensex touched 30,000 mark, Nifty has already crossed 9000. As the stock market is touching new highs, many of us get jittery about what to do some also get over excited in this market. SO what should we do in this kind of situation and how to avoid temptation and errors while making most in this kind situation.

1.  Numbers are not just numbers look behind them

If we just look at a number in isolation it does not gives any clear information. Time value of money and the basics behind the numbers are more important to understand its significance.  Similarly the absolute number of the Nifty, BSE Sensex or any individual stock may not give a correct picture. We should look at Valuations based on earnings, growth and other factors to determine the actual value of that stock or group of stocks.

2.  Asset allocation is the Key

It is true that equity valuations are currently high as compared to historical averages. Hence expected returns are less. Still if we compare equities with other asset class i.e. bonds, gold, real estate it remains relatively attractive over the long term period of three years and more.

Another factor that determines market levels is Cashflow in the market of funds. Foreign Institutional Investors continuously buying Indian Stocks and Domes Institutional Investors like Mutual Funds are also buying. In this scenario when we do not have any other better asset available we can keep on investing in equity market,  We understand that equities may be volatile in the short term, but investors with a medium to long-term horizon should continue to invest in equities, preferably through SIPs. A staggered approach for investments through SIP or STPs could be better way in this scenario.

If we have a large sum to invest, it is best to park the funds in liquid or ultra short term bond funds and do a systematic transfer to equity funds over a period of time. This may help to average out the purchasing cost over a period of time.

Another strategy for investments in this scenario could be dynamic asset allocation or balanced funds. In Dynamic asset allocation funds mutual funds reduce equity exposure when the market valuations are high and increase it when the valuations are low. Some funds reduces the equity exposure below 65% required for getting equity tax benefits through derivatives.These funds can also be looked at to reduce equity exposure while getting the tax benefits in more efficient way.

Corporate Results, inflation behaviour and the interest rate movements, implementation of GST are major factors which should be looked at in near future to seek the direction of the market.

3.  Understand the actual risk

Normally, the large cap stocks are value higher as compared to mid and small cap stocks. However, currently it is the other way.  Mid & Small cap stocks are value much higher as compared to the large cap companies. This could get corrected to its normal levels in near future. In this scenario its better to be more careful while selecting stocks or mutual funds so as to avoid potential risks.  

4.  Nothing comes cheap so be careful

When markets are at very high levels people get tempted to buy penny stocks assuming they may multiply in future. Some people think that if stock price of a a company is very little it means the risk is also little but this is not true. Ultimately the return is calculated on percentage terms. If a stock priced at Rs. 4 falls to Rs. 2 or a stock of Rs. 1000 falls to Rs. 500 the loss will be same. As a basic we should always remember that any company’s stocks has to be valued on the fundamental factors like business growth, management, financial performance etc. and not on the absolute price.

Further little priced penny stocks could also be easily manipulated by operators and are best avoided.

5.  Trading has more excitement than actual gains

We keep on hearing various stories from friends & relatives that someone has made lot of money by day trading or playing in the futures and options (F&O) markets. It’s not so easy and may not be always true. We should understand that trading is a specialized activity and requires lot of expertise and knowledge of the market. Small investors should better to keep themselves away from these temptations.

6.  Insure the risk

The large investors who have significant equity exposure can take hedging positions to reduce their risks in equity market. investors can follow less aggressive hedging strategies like buying puts at higher levels and selling at lower levels to protect themselves from significant falls along with covering a steep rise in the markets. 

When something goes to a new and uncharted territory, proper prudence and maturity is required to see beyond the current hype so as to not get carried away with it and also to keep the eyes on reality. The Indian stock market may be like that at this juncture hence we should keep our eyes and ears open while taking any kind of decisions in this market.