From the climbing millennial living pay check to pay check, to the seasoned business tycoon with coffers overflowing, there are some all too common money mistakes that investors repeat with alarming consistency. Some of these stem from ignorance about how certain financial instruments work, while still others may be attributed to deeply rooted behavioural biases. Here are a few common ones to watch out for.
Mutual Funds Do this…
Before anything else, understand that mutual funds work differently from the traditional investment instruments you may have been used to before. Returns from mutual funds are non-linear and market linked, and so you must be mentally prepared to sit patiently through low to negative return phases. Build your portfolio in a top-down manner, with a thorough assessment of your individual risk tolerance leading up to a target asset allocation. Ignore the noise and stick to this target asset allocation resolutely. Review your portfolio once a year to rebalance, optimise, and weed out laggards.
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Beware of the perils of investing unadvised, especially if you’re a newbie. Whatever your choice of engagement model (RIA or distribution), it pays to have a trusted advisor by your side. Don’t make the mistake of just “buying” into new fund offers or direct plans on a whim — over time, your underperforming portfolio will look more cluttered than a supermarket grocery bill! Also, investing simply based on past returns, especially short-term, can land you in some serious trouble. Remember, what goes up could come down and vice versa.
Insurance Do this…
As far as financial instruments go in India, there are few that are as widely misunderstood (and mis-sold) as insurance. The concept of paying somebody just to take on your financial risks is one that has very limited acceptance among the masses in our country. Stay ahead in the game by educating yourself on the real purpose of insurance. Before you sign above the dotted line, understand the specific risk that your policy is covering, and ascertain whether the cover is sufficient. Follow the simple rule of sticking to pure risk products that have zero payoffs at the end, such as term insurance and health insurance. Aim to optimise your risk cover instead of trying to solve two problems with a single financial instrument.
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Do not make the mistake of buying a “traditional” insurance policy. Much of their terms and conditions are obscured within verbose fine print. You are bound to discover later, to your horror, that the “returns” from such products work out to barely 5-6 per cent on an annualised basis, and over a very long time horizon to boot. Typically, they also add precious little value in terms of augmenting your life cover. Remember, the same principle applies to child education plans or money back plans that are of the traditional kind.
SIPs Do this…
If there’s one really good thing you can do with your SIPs, it’s the act of linking them to your future goals using an online programme or even a simple spreadsheet. Aligning your SIPs to your goals brings in a plethora of benefits that go beyond the obvious. First off, your choice of asset class (equity or debt) will be governed by your time horizon, and not your attitude to risk taking. You’ll also be able to cultivate ‘big picture’ thinking, and remain resilient during tumultuous market cycles. Lastly, you’ll automatically have the proclivity towards stepping up your SIP amounts periodically, which can turbo-charge your goal-based investments and really put you in the driver’s seat.
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Don’t stop and start your SIPs in an imprudent effort to time the market. Remember, SIPs operate on the principle of rupee cost averaging, and they actually draw upon the volatility that’s intrinsic to markets to deliver superior risk-adjusted returns in the long run. Don’t become restless and impatient if you don’t see returns stacking up in the early stages of your investment. Also, don’t spread yourself too thin by starting SIPs in too many funds. Anything more than five is most probably an overkill, and will result in overdiversification.
Retirement Planning Do this…
In a word, go as aggressive as you can! Retirement planning, for most of us, is likely to be a really long-range goal. Allowing your risk profile to dictate terms and sticking purely with low-risk investments such as PF, fixed deposits and life insurance can severely impact the quantum of your final retirement corpus. Over a 25-year savings tenure, the different between an 8 per cent return and a 12 per cent return is a factor of 2x. Consider diverting the bulk of your retirement savings into high-risk/high-return assets such as small and midcap mutual funds and NPS (with your equity allocation maxed out).
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Don’t delay your retirement planning until the last moment. It’s a very common practice to delay planning for this critical goal until we hit our 40s or even 50s, and then hit the panic button. Even Rs 20,000 saved for 25 years could add up to Rs 3.75 crore by the time you hang up your work boots. To save the same corpus in 10 years, you’d have to stash away more than Rs 1.65 lakh per month, which could put severe pressure on your finances at a time when your kids could be entering college or getting married. Don’t succumb to the temptation of drawing upon your retirement funds to finance short-term needs. Even small redemptions could cost you dearly in the end.
Children’s Education Do this…
While you could be saving an adequate sum for your child’s higher studies, don’t forget to “protect” this goal alongside. This involves buying a term insurance plan with a death benefit that’s equal to the present value of your target amount, discounted by a reasonable rate of return — say, 10 per cent. A financial planner can help you arrive at this number. For the term plan that you’re earmarking for this purpose, make sure you appoint a trusted person as an appointee, who will receive, invest and deploy the sum assured in case of your unfortunate death. Furthermore, make sure you close-loop your goal protection strategy by drafting a will, clearly mentioning the sole purpose that the policy proceeds must be used for.
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First, don’t just save an arbitrary amount keeping today’s education costs in mind. Depending upon the area of study, you may have to contend with supernormal inflation rates ranging from 8 per cent to 12 per cent. Factor that into your calculations. Second, counterintuitive as it may sound, avoid anything with “child plan” written in it. Chances are it’s a fancy sounding but low yielding insurance plan that’s going to prove pretty much fruitless in the long run. Stick with SIPs in aggressive mutual funds, and you should do just fine.