What is the best way to achieve investment success is a question that haunts every investor. Though achieving investment success is not a hugely difficult task, the challenging part is to achieve it on a consistent basis and that too in line with one’s investment objectives. Many investors struggle mainly because they do not go through the process of analyzing their investment needs in a proper manner. There is a general tendency to follow a haphazard approach to investing.
Investing is a simple process that requires planning, perseverance and time. Therefore, one needs to begin with having an investment plan in place and a strategy to implement it. Before starting the process, it would help investors to know that risk is an inherent part of investing and that there is a direction co-relation between risk and reward. The right way to make an investment plan is by taking into account factors like current financial situation, investment objectives, attitude towards risk and the time horizon. The level and the type of risk would mainly depend on one’s time horizon i.e. the length of time one has to achieve an investment objective. For a short term investor, volatility is the main risk. Therefore, a short term investment strategy should focus on capital preservation. For a long term investor, however, important aspect is the annualized rate of return as volatility tends to work itself out over time. Moreover, compounding plays a major role in the wealth creation process of a long term investor.
As regards the risk, all of us have our own definition of risk. While investors recognize the risk of losing a part of the capital, inflation risk is ignored by them. For a long-term investor, it is crucial to earn positive real rate of returns i.e. returns minus inflation to take care of escalating costs. The real issue, therefore, is how can one find and maintain one’s balancing point that can ensure success at a risk level one is comfortable with. This is where an asset allocation strategy has a role to play. An asset allocation strategy helps in spreading investments across different asset classes such as equity, debt, real estate and commodities thereby reducing portfolio risk.
It is important to choose the right investment option while investing in different asset classes. It is equally important to remember that different asset classes perform differently in different market conditions. For example, stock market does well during an economic boom, and loses ground during recessionary times. Bond market, however, goes in the opposite direction. While the recessionary conditions are good for the bond markets, a booming economy is not so good for it. Therefore, one shouldn’t allow short term turmoil in the markets to block one’s vision for a better financial future. One needs to look for appropriate and tax efficient options rather than investing in a state of fear and miss out on opportunities to make the money grow at a healthy rate.
Thankfully, there are various investment options to suit the needs of investors with different risk appetite and temperament. For a long term investor, equities are potentially better than other options. At the same time, the probability of an investor facing higher volatility in the short to medium term goes up too. This risk, however, can be tackled by following a disciplined approach whereby money is invested on a regular basis. Remember, the level of exposure to equities vis-à-vis the overall portfolio size decides the likely impact on the overall returns and the level of risk. For investors who are not familiar with equity markets, mutual funds (MFs) can be a better option as they are not only diversified by nature but also offer many other benefits such as professional fund management, high level of liquidity through open-ended funds, transparency, flexibility, variety of options and tax efficiency. While investing in MFs, it is always advisable to focus on diversified equity funds. Though some of the aggressive funds like sector and thematic funds can be tempting, one should avoid investing in them at least in the initial phase of portfolio building.
For conservative investors, the traditional investment options like bank deposits, bonds, small savings schemes and debentures have been the mainstay of their portfolios for years. Though as a category, these instruments do address their concern for the safety of their hard-earned money; most of these do not have much of a role to play in the wealth creation process. That’s because they not only offer low returns but also are not tax efficient barring an exception like PPF. Besides, lack of liquidity in most of these instruments can be a major hindrance in the flexibility required to make changes in the portfolio from time to time. The time has come to look beyond these for at least a part of the portfolio and explore options like debt and debt related funds offered by MFs. These are not only tax efficient and flexible but also have the potential to provide better returns.
Gold continues to be one of the effective investment options. However, considering that ultimate role that gold plays in a portfolio is that of hedging against the inflation, one needs to restrict the exposure to gold to around 10-15% of the portfolio. Here too, MFs have a role to play. In today’s times, the better way to invest in gold is through Gold Exchange Traded funds (GETF) rather than buying physical gold which has many risks and logistic issues. GETFs can be bought on a stock exchange through a stock broker.
Last but not the least; take help of a professional advisor to guide you through the maze of investment world. However, it is equally important to know that you, yourself, have an important role to play in the decision making process. No one will know about your objectives, needs and risk profile better than you. While an advisor can help you in terms of determining the course of action and selection of investment options, you have a big role to play in defining the parameters.