During our childhood, we learned a story about Cinderella and her adventures. Just have a small recap of what happened in it. She was an abandoned daughter who served an evil stepmother, got a wish from a fairy to attend the Prince’s ball and when returning back, she lost her glass shoe. The prince, in order to find Cinderella, ordered his men to find the woman to whom the shoe belongs. All the women who wanted to be the princess, made their best attempt to fit in the shoe but failed miserably. Eventually he finds Cinderella whose feet fit in the shoe perfectly and the Prince and Cinderella lived happily.
Lets translate this story into our personal financial journey. The prince is the goal which we need to achieve, the shoe is the avenue we choose to invest and all those women who tried to fit the shoe are the wrong investments. Bad investments can be an enemy to your cash flows if not discarded and replaced with a more effective, growth oriented and appropriate investment option.
Our investments have always been hampered with over cautiousness, skepticism of the market, fear of volatility and resistance to accept a change in the investment ideology. This is largely due to lack of awareness of the various options available for investing. We still end up doing traditional, non productive and obsolete investments which sometimes don’t even beat inflation effectively. So let’s find out what does an appropriate investment tool means and how it can help an investor in achieving the goals effectively.
In order to identify the correct investment option, one needs to follow the basic rules of goal based investing i.e. identify the goal, prioritize it and then put a value to achieve. Then the next step is to give a timeline to the goals i.e. Immediate term (3 months to 15 months), short term (16 months to 3 years) . medium term (3 years to 8 years) and then long term (more than 8 years). Once this classification is done then the next step is to choose the investment tool for it.
1) Immediate Term – The most effective and easy investment to choose is liquid/money markets/ultra short term funds.
These investments are based on short term loans issued mostly by PSU’s or RBI ( T-Bills) which means they are very safe and due to the short duration, which is less than a year, it makes them very liquid in nature.
Returns – 8% – 9% per annum
What not to do – Fixed Deposits, Recurring deposits and savings account deposits.
2) Short Term – When the investment horizon is more than 15 months, then the investor can take invest in based investments to enhance the returns. But, the equities needs to be well mixed with debt based funds to ensure stability in the investments and capital protection. Debt Funds may include money markets and short term funds. A lot of investors use close ended investments in such situation but these are not liquid at all and the investor loses control over the investments.
Returns – 9.5% – 12%
What not to do – Fixed Deposits, FMP(Fixed maturity plans), Recurring Deposits, Chit funds
3) Medium Term – If the investment horizon is for a period of 3 to 5 years then the equity exposure can be increased to such a level that it can be higher than debts. In this period the equity markets can give higher returns and debts also helps stabilize the investments. Some aggressive debt funds like Gilts and Medium Term would be suitable.
Returns – 10% – 13%
What not to do – All equity based investments, Insurance plans, Long term fixed/recurring deposits, FMP’s(Fixed Maturity Plans), Post Office savings
4) Long Term – In such cases the investment towards equities can increase to the highest level but it is ideal to add other asset classes to diversify and lower the volatility risk in the investments. Due to the long term nature of investments one can expect higher returns. Debt funds may include Gilt, Medium term and short term funds.
Returns – 12%-15%
What not to do – Insurance plans, fixed income savings scheme (post office, PPF etc).