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Do you follow your parent's advice when it comes to investing? - Outside View by PersonalFN

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Do you follow your parent's advice when it comes to investing?
Aug 26, 2014

In the earlier times, many individuals used to invest their hard earned money only in Fixed Deposits (FDs), Recurring Deposits (RDs), Bonds or simply keep cash in bank (i.e. in savings bank accounts). The usual mind set was to keep money safe from risk and market volatility. In fact, even today a lot of parents tell their young professional children to start a RD to instill in them the habit of saving regularly. Although parents always think for the welfare of their children and are more experienced, times are changing dynamically and thus following the same investing strategy as your parents did might not yield you the desired returns.

Today, even to send your kids to a decent school, one needs to spend a huge sum for fees and other expenses. The cost of necessities such as food, clothing etc. is also sky rocketing. In order to combat inflation and enjoy a suitable standard of living, merely saving in RDs, FDs or bonds won't be enough. This is because the real rate of return in these investments is quite low after adjusting for tax. Hence one needs to invest in productive tax efficient instruments that can provide a higher real rate of return.

Now you might be wondering, "So where should I invest to earn good returns?" Well, equity as an asset class has the ability to compensate anyone who invests prudently and with a longer time horizon. It not only can fight the inflation bug, but also reward investors adequately and help them to meet their financial goals. Investing in equity directly through stocks requires a lot of expertise and research on the part of the investor. Since most people won't be well-equipped to do so, the best way to invest in this asset class for them is through mutual funds. You see, mutual funds are managed by experts and are the simplest way to invest in a variety of investment instruments. However, investing in any mutual fund scheme randomly won't bring fruitful results. You must select a winning mutual fund scheme to earn handsome returns on your investments. In order to select such schemes, it is imperative to consider the performance, fund management and costs associated with the scheme, among host of other important quantitative and qualitative aspects.

To avoid the risks associated with timing the markets, PersonalFN recommends investing in mutual funds through the Systematic Investment Plans (SIP) mode of investing. The SIP route enables you to invest regularly and build wealth over the long term. It not only reduces the burden of defraying money at one-go from your bank account, but also absorbs the shocks of the equity markets due to the rupee-cost averaging effect and powers your portfolio with the benefit of compounding.

However, while investing you must also remember that investments in any instrument must be done only after determining a suitable asset allocation pattern. If you have recently started working and are young with limited responsibilities, then you may consider having a greater exposure to equities in your portfolio through investments in diversified equity funds, wherein you may consider growth and opportunities style funds and / or those which focus on investing in stocks in the mid and small cap domain. To further diversify your portfolio you may also consider investing in gold. But while you do so avoid investing in physical gold and instead prefer the smart way of investing in gold i.e. through gold ETFs or gold saving funds. You see, gold is an effective portfolio diversifier and due to its tendency to do well during times of economic uncertainties, can act as hedge in your portfolio. As far as your exposure to debt instruments is concerned, you could keep a diminutive portion of your assets in debt for liquidity purpose and in case your goals are far away from occurrence. But if you are burdened with several financial responsibilities, which may therefore result in you being risk averse; debt investments should be a dominant portion of the portfolio to lower the risk of loss of capital. So you got to have a fair balance between equity and debt instruments, depending upon the situation while allocating your assets. Moreover, you also need to review your asset allocation as you progress in time. So, as the financial goals for which you have been investing come closer, start redeeming risky investments and switch to safer asset classes for protecting your accumulated corpus.

But remember, all your efforts to maintain a suitable asset allocation and build a desirable corpus will go in vain if you do not have an adequate insurance cover. In order to ensure that the financial goals of your loved ones get fulfilled even in your absence, it is necessary to have an optimal insurance cover. However apart from having the right amount of cover, it is also essential that you select the right insurance policy. Your parents might have purchased traditional or endowment plans, which were sold to them by some commission based agent, to meet their insurance needs. However, remember that these plans not only fail to provide an adequate insurance cover but also generate meager returns. Hence, at PersonalFN we believe Term Plans are the best when it comes to indemnification of risk to life. Term insurance is the purest form of insurance policy which provides you a high amount of coverage at a very low premium.

PersonalFN is of the view that as compared to the older generations, people today face increased stress and tension due to rising aspirations and financial responsibilities of their loved ones. It is important for you to understand that different times require different strategies. If you adopt the above mentioned facets in a prudent manner, then living a happy financial life will not be a far-away dream.

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.


The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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