Friday, April 22, 2011

Setting Goals Before Investing

As kids we would have read the famous story of Alice in wonderland. In the story, she once reaches a crossroads and was not sure which road to take. A passing cat asked her where she wanted to go to which Alice replied “ I don't know!”. The cat then smilingly replied “Then it doesn't matter which road you take”.

The classic moment in the story is true to each of us in our daily lives. In our lives too we are often at crossroads like Alice and unknowingly we choose our roads without knowing where we want to reach in our life. When it comes to investments, this is in fact the reality for most of us. Since we don't know what we want to achieve from our investments, any investment decision helps us achieve it.

The need for setting goals can never be undermined, be it business, personal life or your personal finance. Every wise investor would know the purpose or objective behind his/her investments and more often than not, the same would be geared towards achievement of some goal in life. The goal can be any personal or financial goal like retirement or a fixed amount at any time in future, with the condition that it can be monetised or spoken in terms of money. 
Advantage of setting goals:

The following are some of the benefits of setting financial goals in your life...
  • Goals make you think & prioritise: When you actually start planning for your goals, you are forced to evaluate the need, intensity and priority for each of your goal in life. This gives you a lot of clarity on which goals to pursue and in what priority. Often important goals which are not on the top of your mind, crop up and make you think. 
  • Goals make you take action: After identifying goals, one becomes more inclined to take actions for achieving the goals. We often neglect or delay the action because the goals are not very clear in our minds. Defining goals would help you realise the urgency for taking appropriate actions
  • Goals tells you where you: Unless the goals are defined, we would not be able to comprehend our current situation with regards to the future. Defining goals also clarify their feasibility and practicality for achievement and accordingly, depending of our current situation, we may either change the maturity period or the returns expectations or the targets of the goals. 
  • Goals helps you to keep focus: Understanding your goals would help us keep focus on achieving them. This helps us on a daily basis and you may start making a choice between making small expenditures or saving for the goals. Also, we would be more discipled and regular in making our investments and at the same time, not withdrawing from the kitty saved towards the goal. 
  • Goals lead to success: With goals in mind, you will make optimum use of your financial resources when while planning for them. You would eliminate wastefull expenditure, invest in productive asset classes and tend to maintain discipline in your investments. All these factors ensure that you are much closer to your goals then they mature.

Risks of not setting goals: 

Just like we discussed the benefits of goal-setting, there are similarly down-side risks to not setting and planning for goals. 
  • Compromise on goals: Not identifying or delaying planning for your goals for too long would ultimately lead to situations wherein you would need to either compromise on your goals, in terms of value or by pushing our goals into future. However, more often than not, goals like child marriage, education, retirement, cannot be postponed and it is best left unsaid as to how you would plan when they actually arise. You may even loose out on smaller goals & moments of happiness like say vacations, which would be very much possible if you are planning in advance for them. 
  • Failure to make optimum use of finances: Not setting goals and planning for same will lead to misdirected investments and spendings. Chances are that there would be unwarranted spending which would had been invested had planning been done. There is also high chances that you would save in asset classes or product which are not in line with your goals. For e.g., While planning for retirement after say 15-20 years, you will probably identify equity as ideal asset class for you to invest. However, in absence of same, you may avoid equity investing as a risky asset since your goal & time horizon is not clear. 
  •  Compromising on Long-term financial well-being: In long term, better management of your resources would enable you to achieve same while also creating and protecting your wealth at the same time. Needless to say, you are more likely to be credit-free, while having appropriate wealth at disposal for a better life, especially post retirement. By avoiding goal setting & planning, you may well be inviting financial in-stability or insecurity in long-run since you may be forced to take credit or dilute your unplanned investments when your goals mature.
Setting financial goals is something that we are not completely unaware of. It is like basic common-sense. We all know its importance but rarely do we plan and act accordingly. We have discussed in detail the benefits and risks of not setting your goals and planning for them. Very clearly, they have potentially very far-reaching & defining consequences to your financial well-being in future. Those who are wise would understand its criticality and start taking appropriate actions towards it in immediate future. And for those who fail to do would leave matters increasingly to luck and chance for as long as they continue delaying same.

Wednesday, April 20, 2011

Need for Financial Planning

Over the last few years, the term “financial planning” has been very often used and heard by many of us. In this article we explore as to what this term really means and why it is important for us all.

Simply put, financial planning is the process of meeting your life goals through proper management of your finances. The life (read financial) goals can include buying a home, saving for your child's education & marriage or planning for your retirement or protecting your family. It is a process whereby a qualified financial advisor will consider your entire financial situation and goals and provide you with appropriate action steps to fulfill your goals and better manage your finances. It is not a one-time process but is continuous in nature as your life situations and finances change over time. You also need to regularly review your financial plans & your investments to ensure that you are well on track to meeting your financial goals / objectives.

Given the nature of today's life, with growing uncertainty, rising aspirations and increasing costs of living, doing a thorough financial planning has become a must for each of us. It is also better to plan and be ready for any situation rather than be passive and wait for things to happen before doing anything about it. A special case to mention is of Retirement planning, which has become very critical since the average life expectancy has increased and appropriate planning is needed to ensure that your 20-30 years of your life after retirement is dignified, peaceful and self reliant.

An important point to understand is that financial planning should be done through a qualified financial planner, preferably a CFP (Certified Financial Planner), or an expert who can advise you holistically on your entire financial situation. Typically financial advisors give advice on areas of insurance or Risk Planning, portfolio or Investment Planning and pension or Retirement Planning. There are also other important areas like Tax Planning, Estate Planning (wills & related aspects), Cash Flow planning, etc. which can be covered in your comprehensive financial plans. Remember that the advice you receive from an insurance broker or a mutual fund distributor or your Accountant will typically be limited to their own area of expertise with chances that they will recommend their own products, independent of your actual financial need.

A financial planner is like your Financial Doctor of your personal finance, who will closely study each aspect of your financial life and accordingly give recommendations. Nothing is free and a financial planner would typically charge you 'fees' for the advice since this is his/her profession. This is something that we should learn and value just like we do it for almost every other service that we enjoy. If we are hesitant in paying fees, we risk getting free but biased advice from people who would seek income from other source, namely – product commission. A good, unbiased advice can help us save a lot of money and give peace of mind in long run.

We should understand that making our financial and investment decisions without a proper financial plan is like buying and eating medicine without any doctor's prescription and medical test. Typically after you receive recommendations for asset classes or actual products from your financial planner, you are free to purchase such products from any source or distributor.

To summarise, the following are the key reasons or benefits that you would get upon undergoing proper financial planning

  • To look at your complete financial situation, including your assets, liabilities, cash flows, financial goals, risk appetite, life situation, family background, etc.
  • To plan systematically for your financial goals and objectives, including life insurance, health insurance, retirement, child planning – education & marriage, house purchase, estate planning, investment planning, etc.
  • To make your financial life better and secured for yourself and your family and ensuring that all financial goals are achieved.
  • To better understand and learn about your financial situation and understand the reasoning and logic behind all recommendations made. Also to better understand the different asset classes and financial products and their suitability to you.
  • To regularly review the progress of financial plans and/or to revise the financial plans to accommodate any major change in personal life or financial situation.

Most of us do not have adequate information about financial planning and only in recent years has there been some growing awareness about it. Most of us though still believe that they are knowledgeable and smart enough to decide upon their finances on their own ignoring the fact that this is a very broad subject that requires professional expertise. We are ready to visit and pay an accountant, doctor, lawyer or any other professional but are shy when it comes to financial planners. A better, secured financial life is a dream for all of us which, with proper financial planning, can become a reality. The need is to be understand this crucial part of our life and give it the importance and priority it deserves.

Tuesday, April 12, 2011

Myths of Mutual Funds

Mutual funds have witnessed a growth in popularity over the past few years. The trend has seen retail investors increasingly participating in mutual funds. However, there is also a high level of misinformation and myths surrounding mutual fund investing in the minds of the common investor. The low awareness levels breeds many misconceptions that refrain both existing and prospective investors from making the most that mutual funds has   to offer.

In this article, we debunk 10 of the common mutual fund myths often heard on the streets....

Myth 1: “Mutual Funds invests only in equities.”
Fact: Mutual Funds is a like a vehicle carrying which can carry any investment product. The underlying investments of a mutual fund scheme can be in any asset class, be it equities, pure debt products, money market instruments or a mix of these. The fact is mutual funds offers schemes in all of these asset classes. This can be known from the Average Assets Under Management (AAUM) which in Equity oriented schemes is Rs.2.35 Lac Crores and in Debt oriented schemes is Rs.4.44 Lac Crores (Dec. end, 2010).
An investor can easily come to know where the investments would be made from scheme objective and stated asset allocation. Mutual Funds have different schemes like Equity or Growth Fund which invest predominantly in stocks of equity markets, Debt funds which invest into debt products like government bonds, corporate debentures and treasury bills. Balanced Funds mix equity and debt both, Money market or Liquid Funds invest in short term debt instruments.
Thus, mutual funds is not just about equities but it also offers a lot more choice to suit the needs of any investor.

Myth 2: “I invest in Direct Equity. So there is no need to invest in Mutual Funds.” 
Fact: As explained, mutual fund does not only invest only in equity and investor may look at mutual funds for all asset classes, including equities. Investing directly in equities requires proper research, time and adequate capital. Often investors end up investing in few companies and a small number of equities of a company which are not backed by thorough research but on 'tips'. Mutual Fund helps investor to invest in number of equities with the same amount of capital. Thus there is a strong benefit of diversification as the investments do not get  concentrated in very few of the stocks or in a single stock which is very risky. Further still, there is the benefit of experience and professional expertise of the Fund Manager and the research team which makes the investment decisions on your behalf. This is again a major benefit since most of us do not have the time, expertise and infrastructure to actively manage our direct equity investments.
It is thus, wiser to invest in mutual funds and gain from the diversification and professional expertise of the fund house.

Myth 3: “Mutual Funds are very risky as mentioned in their advertisement - “Mutual Funds are subject to market risks.”?
Fact: The warning is a statutory requirement to make investors aware that the investments made by mutual funds are in products, the value of which is driven by markets and hence cannot be guaranteed. In other words, it means that the funds cannot promise guaranteed returns to the investor.
Investors should understand that the risk depends a lot on which scheme are you investing in and for what duration. One can reduce risk by choosing the right asset class and investing for the right duration. The risk for a debt scheme will be far lesser compared to a sector specific or small-cap focused equity scheme. Investing in equities through SIP or Systematic Investment Plan, where you contributed at regular intervals, also helps reducing risk a lot. Further, the diversification into multiple stocks /products and asset classes in a mutual fund scheme also helps reduce the risk as compared to investing directly. Rather than fearing risk, one should understand the same and invest wisely according to one's own risk appetite and investment objective.

Myth 4: “Mutual fund investments do not give handsome returns.”
Fact: This is not a correct statement to make as it generalises all mutual fund schemes for performance. When comparing performance of products, the underlying asset class should be similar in nature and comparison should be made with relevant benchmarks. Historically, in general, mutual fund schemes have proven to be a very good performing investment vehicle for investors. There have been visible benefits of professional expertise and diversification of portfolio on the returns of mutual fund schemes. Mutual fund schemes have also largely outperformed general market indices in past. This can be seen from the average returns of diversified equity schemes, as a group,  which is at 23.58% in 10 years as compared to the Sensex which has given 17.77% (as on 11/03/2011). (Source : Internal, calculated taking 36 schemes in to consideration)
Myth 5: “It is always better to invest in the mutual fund with the low NAV than high NAV.”
Fact: There is no difference in returns when investing in a higher or a lower NAV of a mutual fund scheme. The NAV is quite different from a stock price. An investment of Rs.10,000 in two mutual fund schemes of NAV say 15 & 45 will yield the same returns to you, assuming similar performance of the schemes. The NAV is a mathematically calculated price of the scheme based on the price of underlying securities. An NFO at Rs.10/- or an existing NAV of  Rs.15 or 45, will invest in the same stocks at the prevailing market price. Thus, a lower NAV or higher NAV doesn't matter while investing between two mutual fund schemes. This perception is can also be seen when an investor invests in a NFO thinking that the NFO is available at unit price of say Rs.10/-. Investors should look at other important factors while investing in schemes rather than looking at NAV.

Myth 6: “It is better to invest in a mutual fund that gives good dividends.”
Fact: While investing in a mutual fund, investors can choose between the growth and the dividend options. Most mutual fund schemes offer the choice of Growth / Dividend Reinvestment and Dividend Payout option to the investors. It is not mandatory for mutual funds to pay dividends regularly if they are offering such options.
Between a growth option and a dividend reinvestment option of a mutual fund equity scheme, there is the no difference in the returns. While in growth option, the NAV increases, in a dividend reinvestment option, the units increases proportionately. However, an investor can choose an option of dividend payout if there is a need of  liquidity. The decision as to which option to opt should be on the basis of returns performance. An investor should consider other important factors of a scheme and his own requirements while investing in an scheme or opting for an option.

Myth 7: “My funds get locked if I invest in mutual funds.”.
Fact: There is no lock-in period in mutual fund schemes per say and it depends on the actual scheme being purchased. For a person investing in an open-ended schemes, there is complete freedom to enter and exit the scheme at any time. There is a lock-in period of 3 years in ELSS (Equity Linked Savings Scheme) since it offers tax savings under section 80C. In a closed ended fund, the option to resale to the mutual fund AMC is not available, though one can sale in on stock exchange, if it is listed there.

Myth 8: “One cannot invest in mutual funds online like in stocks.”
Fact: Mutual funds are now also available on stock exchange trading platform and one can make online transacts in mutual funds. The mutual funds will be held in your demat account and you can transact with your Trading Account as provided by your broker. This is a recent development and now brings a lot of flexibility and convenience to investors as they can transact without making any physical application. Mutual funds, however, also continue to be available through the physical route and most investors are yet to switch to the online mode. With growing awareness about the benefits of this online route, more & more investors will find it easier to manage their investments in the online mode than through the physical route.

Myth 9:  SIP is a scheme and every AMC is having an SIP scheme.”
Fact: SIP is not a scheme floated by mutual funds. It is a way of investing in mutual funds. Through SIP, an investor can invest a specific amount and at regular period of interval in mutual fund schemes. As SIP is a way of investing in mutual funds, it can be done with any scheme of mutual funds.
SIPs are popular because they help you invest a small amount, often as low as Rs.500, regularly in schemes and accumulate considerable wealth in long term. SIPs also help in automatically timing the markets. This disciplined approach has historically seen investments perform very well for the investors.

Myth 10: “SIP should be started only when market falls.”
Fact: SIP can be best started at any time. Through SIP investor can take advantage of market volatility as he will be investing a specific amount at regular time interval. By doing this, his money gets invested in the mutual fund scheme when the NAV of the schemes is high and at the same time when NAV of the scheme is low. By doing this the investment will be done at the average market price over a longer period of time. If the investor is investing through SIP, it really will have no effect whether the SIP is started when the market is at peak or the market has seen a fall.

Mutual Fund SIP: An Ideal Tool for Wealth Creation

Wealth creation is not easy. But neither it is difficult for wise and disciplined investors. One product that can really help investors in wealth creation is a mutual fund Systematic Investment Plan (SIP). The SIP is a simple and time honored investment strategy for accumulation of wealth in a disciplined manner over long term period. This article takes a closer look at this very important and ideal tool for wealth creation for investors.  

What is SIP?
The SIP is not a type of a mutual fund (MF) scheme. It is a way of investing in a mutual fund scheme. One can invest in a scheme by paying a Lump-sum amount or by making a Switch from an existing scheme or by doing a SIP, if available.
SIP is a very popular and an ideal way to invest as it leads to disciplined and regular investment for investors. It is just like a recurring deposit. Under a SIP, a specific amount, called as SIP Amount,  is invested at regular interval of time, continuously for a certain period. Thus, for example, an investor may choose do an SIP of Rs.1,000/- every month for the next 5 years in a particular mutual fund scheme. Most of the schemes even offer the multiple choices of SIP date in a month to the investor.

Benefits of SIP:

Automatic Timing & Lower average cost of units: One of very important benefits of SIP is that it does automatic timing of the markets. Under an SIP you will be investing a fixed amount every period, irrespective of whether the market is high or low. Thus, when markets are high, you would automatically buy lower number of scheme units and similarly when markets are low, you will be purchasing more number of scheme units. Thus, the SIP investors do not need to regularly track or worry about market movements. Further still, the average cost of one unit tends to be lower over time. benefit is also commonly known as “Rupee Cost Averaging'.

Illustration - Rupee Cost Averaging:
Say you have opted for an SIP in a diversified equity MF Scheme, investing Rs. 1000 every month from March 2010 to Feb 2011. Now if we check the average purchase cost per unit of your investments. It would be lower than the average NAV of your investment over 12 months.

Amount (Rs.)
NAV (Rs.)
Units (nos.)


Note: The table considers a hypothetical NAV trend to explain the concept of Rupee Cost Averaging. The NAV do not in any manner indicate the past or future NAVs of any scheme.

Average Cost = Total Cash Outflow / Total Number of units = Rs. 12000/ 85.80 = Rs.139.85
Average Price = Sum of all NAVs at which you have invested/ Number of months of investment = Rs. 1730/12 = Rs.144.17
Average Cost of Units < Average Price

Disciplined Savings:
Disciplined investing is an important characteristic to create wealth over a longer period of time. Often, investors plan to save in lump sum in some product and many are times such investments are delayed or do not materialize. SIP, with its disciplined way of investing, makes sure that you are saving money at regular intervals. Even small money, invested regularly, for a long period can go very long way in creating wealth. Think of each SIP payment as laying a brick. One by one, you will see them transform into a building.

Power of Compounding:
The famous scientist Albert Einstein called the “Power of Compounding” as the Eighth Wonder of the World. In simply means that the longer you invest, the returns will increase at a greater pace. Thus, the longer the SIP, the better the power of compounding will work for you and hence better chances for creation of significant wealth. Historically, SIPs have delivered good returns. The average returns for diversified equity MF scheme SIP and the power of compounding can be very clearly seen from the following table:

SIP Amount:
(Starting February month)
Period completed – January 2011
3 years
5 years
7 years
10 years
12 years
Average Returns every year of BSE Sensex
Average Returns every year of Diversified Equity MF Schemes
Actual Amount Invested
Average Current Wealth / Investment Value for MF SIP
MF Scheme universe

Actual data as on 31st January, 2011. Source: Internal. Past Performance may or may not be repeated in future. Returns are market dependent and are not guaranteed.

Planning for Financial Goals: Due to its benefits of disciplined savings and attractive returns potential in long term, SIP can be very effectively used for planning your life and financial goals. Think of starting a SIP for your son's education or daughter's marriage or retirement. Your financial goals in life can become realistic if proper planning and use of SIP is done for same. The idea is to match the SIP period with that of the years remaining for any goal. Doing this can really help one plan out for financial goals smartly, even with small amounts of regular investment. This can be seen from the following example: 

SIP Period >
Yearly Return
End Value for a monthly SIP of Rs.500/-
Yearly Return
End Value for a monthly SIP of Rs.1,000/-
Table is for illustration purposes only. Past Performance may or may not be repeated in future. Returns are market dependent and are not guaranteed.

Convenience: SIP can be operated by simply providing post dated cheques or with ECS. The cheques can be banked on the specified dates and the units credited into the investor's account. The SIP facility is available in almost all of Equity, Balance & MIP schemes. Further, SIP can be started with amounts as low as Rs.500/, depending on the scheme. These conveniences also make SIP a very ideal investment vehicle for small & retail investors.

Thus, with the above benefits, it is no doubt that SIP is a true friend for investors in creating wealth. An investor should however know that the market is unpredictable and returns cannot be guaranteed. However, if one is investing wisely for a longer duration of time, it definitely will help the investor in reducing the risk of the market and making significant wealth. The tool is there. It is how you use it that really makes a difference for you.