Investing – a word which evokes different responses in different individuals. Some get overwhelmed with the array of choices available in the market while for others only one or two avenues seem sufficient. Therefore, those who consider the myriad options available, feel investing to be a complicated affair. On the other hand, those who feel that a fixed or a recurring deposit scheme is the only solution, find investing to be a child’s play.
- These are the two extreme ends of the spectrum and yet they are very relevant. Very few of us, out of the teeming billions, have actually mastered the art of investing. Though there are many reasons that why creating wealth is not an easy task, you don’t need a master’s degree in finance to master the art, just some insight, research and open-mindedness and your work is done. Furthermore, certain principles also require adherence to in the context of investing, if you truly want the best portfolio which while promising maximum returns also ensures that your financial life journey is smooth.
What are those principles you might ask. Well, they are not something mysterious. These principles are very commonly known and yet, we don’t apply them when we make an investment plan. So, what are the principles of investing, let us find out.
– Why do we save? Is it only for generating returns? Won’t the wealth created be put to any end use? Our investments are driven by our future requirements. Whether we want to own a house, a car, send our children to the best educational institutes, plan their higher education or marriage or plan for our retirement, our investments always have an end use. Always know the importance of goals in investing.
However, at the investment stage, these goals are often ignored and we invest blindly. Earmarking our investments for respective goals is conspicuously absent. As a result, when it is time to fund our goals our investments do not come to our rescue completely. So, our investments should be dictated by our life goals. Their time horizon should be planned in such a manner that they would be available when it is time to meet our goals. Do you want to plan multiple goals? Try this composite financial goal planner calculator
– Another folly we make with our investments is having an undisciplined approach. Disciplined investment makes us save compulsorily and also prevents premature liquidation of our investments. Thus, this principle helps us in accumulating a stable corpus through regular savings and non-withdrawal, which, in turn, helps us in meeting our financial liabilities whenever they arise.
Long term investment
– The last principle and the most relevant one is investing with a long-term perspective. There are multiple benefits of a long-term investment approach, maximum returns being the first of them. Perhaps this is why experts always advise individuals to start investing and building a portfolio at the start of their career. The longer you stay invested, the better benefits you would accrue. So, don’t be tempted in liquidating your investments early even if the markets seem volatile, stay invested and enjoy the underlying benefits. For more clarity, read this 6 things people in their 20smust do for a better financial life
Though all the principles are important, the last one deserves a special mention because most of us are more tempted with short-term results. It is no mystery why individuals like investing in shares and mutual funds. It is because of the short-term nature of such investments that they hold a special attraction. Though the returns generated in the short term may also be good, they are not at their maximum potential. A long-term investment yields the best returns, among other benefits, and is always recommended.
Warren Buffet, the most successful investor of all times, had to say this in regards to his take on long-term investing – ‘No matter how great the talent or efforts, some things just take time. You can’t produce a baby in one month by getting nine women pregnant.’ Well, he couldn’t have summarized the importance of time more simply! Wise men say, good things come to those who wait and even they emphasize the importance of time. So, why do we get so impatient when it comes to our investments? Doesn’t the same long-term perspective apply to our investments too?
It does, and while I can go on about the philosophical importance of a long-term horizon, it’s better to enlist the actual benefits of a long-term investment portfolio for a more convincing read. So, here are the points:
The compounding factor
– We have learned about the concept of compound interest in high school, haven’t we? If you forgot the meaning of it, let’s refresh! In simple terms, compounding is a formula under which the rate of interest is calculated on the principal amount and also on any accumulated interest of earlier years. For instance, take the below example –
The rate of interest on an instrument is, suppose, 8% per annum. Rs.100 is invested in the instrument. The amount after the first 5 years is listed in the table below using the compound interest method of calculation:
Thus, compound interest generates interest on the interest earned too and builds up a considerable corpus.
Almost all investments use the compound interest calculation in generating returns. In the context of compound interest, it is observed that the returns generated on the investments have the potential to multiply the investment many times over if the investments are held for a longer tenure. Thus, a long-term investment would yield a substantial corpus and if you want to enjoy the benefits of compounding, long-term should be your favored mantra.
– Conventional investment avenues which provide a guaranteed return are always issued with a long-term horizon. However, our focus here is the very popular mutual fund investments and other market related investments which can be done for a shorter duration and the returns are non-guaranteed. Since such returns are market-linked, they are non-guaranteed. Though such non-guaranteed returns are better than fixed return investments, one cannot avoid the market volatility factor lurking beneath such investments. With the capital market being highly volatile, our investments have higher probabilities of incurring losses in short-term. Over the long-term, however, such volatility is evened out and the investments provide attractive returns. If you see the movement of Sensex in India, you would understand how the long-term perspective works. So, here it is –
Link - https://en.wikipedia.org/wiki/BSE_SENSEX
Though the market crashed in 2009, by the end of 2013, the growth was substantial compared to the position where it stood in 1991. So, despite volatility, any investment made in the 1990s and held till 2012 or 2013 would have provided investors with about a four-fold return!
Fulfilment of financial goals
– Every one of us has a list of financial goals, goals that we have to fulfill in our lifetimes. It can be planning for your child’s higher education, marriage or career building, creation of a retirement corpus for meeting your lifestyle expenses post retirement, creating assets in the form of a house or a car, creating an emergency fund for those rainy days, etc. Do you know what are the common retirement planning myths
Every such goal requires two things. One is an earmarked corpus for each goal and the other is the size of the corpus. While earmarking a corpus can be attained through right financial planning and asset allocation, creating a sizeable corpus is difficult. Our incomes are limited while the rate of inflation is rising every year. In this scenario, having a considerable corpus is like wishing for the moon. However, since moon travel has become possible, attaining an optimum corpus is also possible. Needless to say, it is the long-term investing coupled with the power of compounding which does the trick. So invest long-term and see your goals being fulfilled with the corpus you accumulate.
Correction of past financial mistake
– With the slew of investment instruments available in the market, it is very easy to get honey-trapped in a wrong investment product. Whether through heeding to your friend’s/relative’s advice or the advice of a financial agent with limited knowledge, investment mistakes can be made. Rectifying the error immediately after investing or in the first initial years prove costly. On the other hand, if such investments are held for a longer tenure, the returns improve (obviously through compounding) and you also learn from your mistakes. Moreover, letting go of such wrong investments after some years removes any exit load associated with such termination or surrender.
The tax angle
– The last and another most relevant benefit is the tax exemption. Almost all financial instruments provide tax benefits only after specified years. Short-term disinvestments are subject to taxation. For instance, tax saving fixed deposit schemes requires a lock-in period of 5 years after which they can be tax-free. ELSS mutual funds have a lock-in of 3 years after which it becomes tax free. In case of open ended equity mutual funds, it becomes tax free after 1 year under long term capital gain taxation Benefit. However, in Debt Mutual Funds, you can avail indexation benefit after holding the product for a minimum of 3 years. So, debt mutual funds do not become completely tax free even after 3 years, but of course, the tax burden reduces significantly. So, in the long run even for debt mutual funds, the taxation part can be completely negated with indexation benefit if held for the long term. Similarly dividends received from mutual funds are also tax free in the hand of the investors. Equities can give tax free returns after 1 year itself, but it makes more sense to invest for the long term as Equity is not a short term product.
All said, it is therefore advised by financial experts and laymen alike that investments should be made with a long-term perspective by tagging each of them with a financial goal which you want to achieve in future. Therefore, avoid the short term investing temptations and look at the longer term horizon while investing your hard earned money.
Mutual Fund Investments are subject to market risk, read all scheme related documents carefully.