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.