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Frequent changes to your investment portfolio can be detrimental

The list of top performing stocks or mutual funds keeps changing frequently. This is of course obvious as the performance depends on various factors and some of these factors are not completely in control of the company’s management. Even good companies with sound management will face ups and downs. There is one obvious question that comes to every investor’s mind – Do we keep churning our portfolio frequently to exit the underperformer and buy the outperformer? My answer to this is overwhelming ‘No’. I believe churning of your portfolio too frequently will do more harm than good.

Let me try to explain further. During the last 15 years, Nifty (including dividend) has grown at an annual rate of 16.7%, to put it in simple terms, Rs. 100 invested 15 years back has now grown to more than 10 times. But, having said that, equity as an asset class is known to be volatile in short periods (see chart below). So, while investing in equity for short term may be tricky, the odds of making money in the long term are quite high.

Now, let us come back to ‘Power of Compounding’, which we had touched briefly in my last article (Read here). This has to be one of the most important financial lessons of all time. As the great Albert Einstein said “Compound interest is the eighth wonder of the world. He, who understands it, earns it … he who doesn’t … pays it”.

Here, we will see how holding your portfolio for the long term helps power of compounding play its magic in the most unusual way. If you hold your portfolio for long term, the winners in your portfolio will tend to become dominant, and the losers will become insignificant. The positive impact of the winners will significantly outweigh the negative contribution and your portfolio will compound significantly. Not sure, right? I can understand your circumspection.

Let me explain this by taking a simple two stock portfolio. Stock ‘A’ is a winner, gives 25% annual return over a period of 15 years, while Stock ‘B’ is declining by 25% annually. How has your portfolio performed? I would say good, rather great. Your portfolio has given an annual return of 19.4%. This example demonstrates the power of compounding.

This magic can also work for you. You just have to be patient and give your money long enough time to grow.

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Wedding on the cards? Here are 6 financial planning tips for the newly – weds!

It is the wedding season and some of you who have recently gotten married or are about to tie the knot in the next few weeks must be aware of the enormous scale of wedding expenses. While it could be difficult to limit these expenses, post your wedding some cognitive steps should be taken for financial planning together with your partner. In order to preempt the chances of encountering incompatibility in financial matters, couples should opt for a plan that is fully acceptable to both partners and promises security for the future.

So before you fly up and away for your coveted honeymoon, here are 6 financial planning tips for you to be aware of.

1. Share and pool ideas to formulate an effective plan

It is very important that newly-wed couples engage in honest conversation that will serve to build a healthy climate of understanding and trust between them. Whereas the couple’s individual financial planning mechanism may have been flawless and effective before marriage, the need for absolute clarity on the way forward is critical to a future that is free of conflict and financial hassles.

2. Decide on a joint or a separate account

In a marriage, the importance of trust cannot be minimized and the couple’s financial standing, as individuals, occupies a space that revolves around the pivot of trust. The couple should not shy away from fundamental decisions such as whether to opt for a joint bank account, where the cash flow can be viewed and managed by either, or separate accounts, especially if both partners are earning members. In either case, it is best not to compromise on the aspect of mutual trust.

3. Build a fund for emergency situations

While the individual partners may have been inclined to spend money lavishly or feed off parents’ income before marriage, it is time for discipline and a sense of responsibility, once the equation changes with the newly wedded status. Adversities, especially those that arise due to financial pressures, should be anticipated and planned for.  Such challenges can take the form of an unexpected illness, a loan repayment schedule interruption or even a failed job. Ideally, this fund should amount to the sum of the expenses of a few months.

4. Save prudently

Saving is a habit which like any other, grows on people. The couple should earmark a fixed amount that will go into their savings. This amount should be determined after accounting for regular and incidental expenses that will be necessary for both sustenance and for lifestyle choices. The ground rule should be that finances are planned to allow for a reasonable and consistent remittance towards savings.

5. Invest smartly

Savings by itself is not sufficient to cater to all our future goals. Income declines or ceases altogether, as life advances and states such as retirement become a reality. It is at such junctures in life that we need a hefty corpus to sustain our lifestyle. It is therefore inevitable to continuously invest your savings in instruments that suit your profile. Inflation and the galloping cost of living can strain the best of financial plans. As such, it may be a wise decision to make the money in a savings account generate enhanced monetary benefits through judicious investment.

6. Get an Investment Plan

It is possible that prior to marriage, the couple had adequate allocation to different asset classes on an individual basis. However, post marriage, one should always look at the combined portfolio. This leads to a need for redesigning your investment plan. The help of a financial expert can be a practical and productive consideration, in this regard.

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Planning to fail in your golden years?

Yet again, a discussion with few friends on a Sunday afternoon has brought me here today. We were discussing about our future plans and each one of us wanted to retire early and retire rich. No surprises there. What surprised me is that my friends only have a vague idea, no concrete plans about how they are going to achieve this goal. This is true for most of us. With rising cost of living and increasing life expectancy, the need to plan for one’s golden years is absolutely necessary.

Lack of a concrete plan for retirement may lead to problems just when you are least prepared for it. As one of the founding father of the United States, Benjamin Franklin, so succinctly put “If you fail to plan, you are planning to fail”.

Most of us tend to underestimate the retirement corpus. If you need Rs. 50,000 for monthly expenses today, will you need the same after 30 years, when you retire? The answer is no. You will need Rs. 2.2 lakhs every month, assuming just 5% inflation. There it is, now I have your attention. Inflation leads to reduction in purchasing power, by slowly but steadily eating up your money. Learn more about it here.

Let me tell you one more thing. With increasing life expectancy, the non-earning period in an individual’s life is expanding. Someone retiring at age 60 after working for 30 years could live on for another 25 years or more. Assuming your current age of 30 years, current monthly expense of Rs. 50,000, inflation of 5% and retirement age of 60 years, the amount of retirement corpus one needs for 25 years after retirement is Rs 5.3 cr and for 30 years after retirement is Rs. 6.1 crore. These are not small sums by any measure. If you do not start to plan now, there is a high probability to fall short.

Are you now thinking when to start investing for retirement? The answer is as EARLY as possible. If you do that, your money gets more time to grow. Each rupee gained generates further returns. This is called “power of compounding”, and this helps you get rich… and richer over time.

Let us take the above example, say you start investing at age of 30 years and continue to do so for next 30 years. To achieve a corpus of Rs. 5.3 cr at retirement, assuming 12% return on your investment, you will have to invest Rs. 15,391 per month. If you delay the investment by even 5 years, the same monthly installment doubles itself to Rs. 28,630.

Don’t feel overwhelmed by all the numbers shown above, you can take help from your financial advisor for this. The key is to start early, invest regularly and choose the right products for your investments.

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Crazy about being fit? How about some financial fitness?

Ajay, my neighbor, was a regular “fitness freak” and never failed to capture my avid respect for his assiduous dedication to his fitness regimen. Three years ago, I was impressed enough to seek his friendship and invited him over for dinner. It was across the dinner table that I discovered his personal dilemma.

His passion for physical fitness was total and amply rewarded. However, he was nursing a deep regret in that he saw no way of realizing his abiding dream of starting a fitness center. In twenty years of working as a gym instructor, he had not managed to save any money.

As a financial planning aficionado, I immediately put on my “financial adviser” hat and apprised Ajay of “Financial Fitness” – how, by following a simple set of money management skills, a stress-free life of financial well-being can be ensured.

 1) Have predefined financial goals

The secret of financial stability begins with sorting and ordering priorities and with defining short term and long term goals. It is essential to achieve this clarity so that resources can be managed and plans laid out, to align with fine-tuned goals. If there is no sense of direction, the destination cannot be reached.

2) Calculate net worth

Once the goals and priorities are defined, assets and liabilities need to be assessed to determine the net worth of an individual. If a huge loan repayment is pending, an investor’s net worth may be negative, a situation that calls for urgent and concerted financial planning.

3) Manage Taxes

Taxes are often considered a necessary evil. While this may be true, there are numerous ways to harvest the benefit of government schemes and reduce taxable income, in the process. Filing tax returns before the stipulated deadlines and avoiding any direct or indirect course of tax evasion goes a long way towards inducing financial discipline.

4) Invest regularly

Simply depositing money in a bank cannot be the most productive way of capitalizing on savings. Investing is a wiser route to beating inflation and simultaneously building a corpus over a period of time. Align investments with pre-defined goals. It is possible that at all times sufficient funds for investments are not available; nonetheless, regular and disciplined investments should be maintained every month. Start small, but start early! Read more about this here

5) Earn as well as learn

Financial knowledge is not everyone’s forte. The lack of adequate information should not accrue as the stumbling block in financial decision making. There is no harm in consulting financial experts. Broadening the knowledge base in this domain can prove extremely rewarding. It is never too late to learn how to earn.

6) Maintain an emergency fund

If there is one thing that will remain constant, it is the ever changing scenarios that life will keep presenting as challenges. To deal with unexpected exigencies efficiently, an individual should have saved an emergency fund, which should ideally equal about 5 to 6 times of the monthly expenses. This will ensure the much needed cushion in times of emergency.