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Here are the points to keep in mind before drawing up the annual blueprint for deploying your funds
It’s time again to make your annual strategic wealth plan. As your employer or business prepares to draw up the accounts, budgets and strategy for the next year, you also need to get to work on how to save and invest for the coming financial year. Many people remain tactical in their investment decisions, buying products randomly. This is more true of the busy professionals, who are confident about their earnings. Sometimes they think that the money in the bank might actually be doing better than a hasty financial decision that could go wrong. A long-term strategy for wealth needs an annual review and it is not a complex exercise.
Investing can take place only after a sensible understanding of one’s cash flow. Without seeking out the details of budgeting or getting into guilt trips about overspending, each one of us can figure out if we frequently run short of cash, or tend to have a surplus in the bank account. Take a look at your bank statement to see how your balance behaved last year. You need an estimate of how much to leave behind in the bank. The focus here is not return, but ease of access and replenishment. Based on how you accessed your cash last year, make an estimate of how much you will need as fixed deposits. You can use a tax-efficient ultra short-term fund to save the same purpose.
Any surplus cash beyond that required for short-term needs should go into building long-term assets. As a rule, long-term assets must earn a return that is higher than the rate of inflation. In exchange for the inflation-adjusted return, long-term assets are accompanied by three risks: liquidity risk, where they cannot be accessed at will; market risk, where the value could vary from time to time; and business risk, where the entity that uses your funds becomes fundamentally weaker. This is why all long-term assets need careful selection.
The primary long-term assets are equity and real estate. While equity is highly liquid and can be accessed in any quantity at any time, real estate is chunky and difficult to access easily. Therefore, the investors who seek real estate as an investment should be sure that they have already built an equity portfolio that they can fall back on, when required. It is also important that equity assets are well-diversified to take care of business risks arising from too much of it in any single business, including one’s own business, if the investor is an entrepreneur.
The simplest way to deal with this risk is to have an investing horizon that encompasses the cycles. Staying long enough through a bull cycle will provide enough buffers to wait through a down cycle and earn average returns over long periods of time. In order to be able to weather the down cycle, the investor needs both the ability and willingness to bear such risk. While willingness is a matter of mental make-up, ability is a direct function of accumulated wealth.
A long-term debt portfolio serves this specific function. Some amount invested in the PPF, bonds, debt funds and saving certificates provides the buffer to take some risks with equity and real estate. An investor who earns a steady income may not care much for other income earning assets. It would, therefore, seem to them that they would not need any long-term debt products in their portfolios. However, the debt portfolio is the bridge between the low-yielding cash assets and higher risk growth assets.
You need to make three broad choices: cash or short-term assets, which can be accessed easily; real estate and equity, which are long-term assets and will grow in value over time; and long-term debt assets, which will create a buffer for risks and unexpected cash. Write down how your savings will move into these three buckets for the coming year.
Begin with the bank account and move the unused balance to 1-year deposits. If you are looking for a smarter and tax-efficient solution, use ultra short term debt funds. If you have Provident Fund and the PPF, continue with them. Identify two debt funds—short-term and long-term—and invest in these throughout the year. Identify four or five equity mutual funds. One index fund, one active large-cap, one or two diversified equity (and tax saving) one, and a small- and mid-cap fund. If you are disciplined, you can opt for a systematic investment plan (SIP). If not, at the end of every month, look at your bank balance and transfer the money to these funds. You can invest at any time and any amount into a mutual fund folio once you have opened it.
If you are thinking of choosing stocks, bonds, IPOs, and monitor them, you should be sure that you have sufficient time, energy and resources for managing them seriously. Always remember that you take business risks on the balance sheet of a bank, an issuer of tax-free bonds, or an issuer of equity capital, when you invest in them. You may or may not get a better return, but you are bound to end up with higher risk.
If you always look at your wealth in terms of these three buckets that serve your needs for cash, buffer and wealth, you will realise that making decisions is easier. You can simplify your financial life if you have an annual strategic plan and stick to it throughout the year. Your money is worth it.
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