Expert advice

Feb 13, 2014,17.08 IST

Are you planning to invest for first time?

Arnav Pandya

Staring on an investment journey is the first step towards financial independence. As a first time investor you have the advantage of going about the process systematically so that a strong foundation is built. This will require some sacrifice and effort but the results can also be significant. A new thought process will enable you to walk along this path in an assured manner.

Long term investing
As a first time investor you should be looking to start early in life and then invest continuously over a period of time so that you are able to benefit from the long time period available over your working life. You should think beyond just a few days or weeks or months as this can make your task easier. The longer the time period for which you hold an investment especially when it belongs to asset classes like equities, the greater the chance of success in the efforts.

Long term investing can be defined as putting money into an investment over a period of time and then holding it for a period that can stretch for several years and in some cases even a decade or longer. There are two aspects of long term investing where the first one involves making the investment not just once but over a longer time frame. The other aspect involves maintaining the investment without making continuous buy and sell decisions. The time period in the term long term could vary significantly between a few years to a lot more and hence this is something that needs focus to determine the right period for you as an individual investor.

Reaching goals
Every investment should be directed towards a specific target or goal. Reaching the goals through systematic efforts should become the central objective of the investment effort.  Everyone has multiple goals and shortage of funds so achieving the goals is a challenge. A major obstacle would be a situation where you could find that due to poor market conditions the investments are not performing as per expectations making the goals elusive.

Tackling this tough challenge is possible by taking a long term approach. This will cover an effort to plan for the investments in a manner whereby you are willing to slowly build your holdings and then stay with them for a significant period of time. This will ensure that short term conditions are evened out and the risk in the investment goes down. This is applicable for all types of investment including equities as well as debt and there will be a lesser amount of pressure to ensure that success is achieved immediately. This will also be a way in which you will be able to select investments after doing the necessary amount of research and can then wait for the expectations to play out. Take an  example where there is a goal to reach a corpus of Rs 50,000 and this can be done by slowly investing as well as allowing  the  amounts to grow over  a period of time. In the chart below starting with an initial investment of Rs 12,000 in a fixed deposit there are small additions over the next two years followed by a break and then another Rs 8,000 investment. The earnings on the existing deposits as well as the new investments ensure that the final goal is achieved. 
 
Indian scenario
Equity markets are very volatile and the main feature of this asset class is that there is a chance of a loss of capital while there can also be a gain that is higher than other investments. There is another factor that can play a positive role in the investment process and this is investing for a long time period.  Consider the situation for large cap funds that are present in the Indian market. These are mutual funds that invest their corpus into large cap stocks which represent the biggest names in Indian corporate sector.

Looking at the position in terms of performance for a short time period like one year would show that the funds are heavily influenced by the short term market movements that are unpredictable. At the end of September 2012 due to a rally in the equity markets around 9 per cent of the total funds had an annual return of less than 10 per cent. A year later by October 2013 the percentage of funds with a return of over 10 per cent was around 30 per cent of the total funds. The figure changes dramatically as we go over a longer time period as over the 10 year time period all the funds present have an annual return over 10 per cent which is a very significant thing. It shows clearly how you can actually build wealth using mutual funds consistently over a long period of time.

Reducing cost
One of the features of investing over a continuous period of time is that there is a better way of management of costs that are incurred. The extra costs that are incurred would go on to reduce the overall returns for you as an investor because these are deducted from your expenses and hence on a net basis you are worse off. There is a need to take a closer look at the expenses that you could end up bearing if there is a long term investing or if there are short term changes that can impact your situation.

If you are a long term investor then your expense of buying a particular stock or a mutual fund would include some small expense like brokerage or fees to a distributor if they are used at the start of the investment. Finally when the holdings are sold there would be some brokerage fees if this is a share and in the interim period there would be some small holding cost or management fees for a mutual fund. On the other hand  when it comes to a short term investment every time there is a transaction there would be a small part of the total figure eaten up by the transaction charges which would include the brokerage fees for a stock along with  the demat charges and other expenses. There is also a 15 per cent tax on short term capital gains if the investment in an equity oriented instrument is sold before one year while this becomes nil after a holding period of a year. In case of a debt oriented fund the short term capital gains tax is added to the income and taxed at the marginal rate while a long term capital gain would be taxed at 10 per cent without indexation and 20 per cent with the benefit of indexation. A small saving of cost can make a significant difference over a long time period. 

Compounding effect
The real benefit of investing for the long term lies in two aspects. The first involves a continuous investment over a period of time so that this would make even tough goals seem very easy to achieve. The breakup of the investment into small parts makes it seem affordable. A small investment of just Rs 5,000 a month growing at 8 per cent per annum can lead to a total sum of over Rs 1.14 crore at the end of 30 years. It would have grown to Rs 29 lakh by the 15th year and Rs 47 lakh by the 20th year. Just looking at the numbers it shows how the rise is greater with the passage of time as the base amount keeps increasing. This is a simple example of how small things can build up to a large amount.
 
The other part is to actually maintain the investment for a significant period of time so that due to the compounding or accumulation of the earnings the figure continues to grow over a period of time.  IF there is a sum of Rs 50,000 that is invested and this grows at 9 per cent per annum then the earnings in the first year would be Rs 4,500 but in the 15th year it would be equal to 30 per cent initial investment and by the 25th year the earnings would be 65 per cent of the initial investment each year. The earnings in the 30th year would be equivalent to the initial amount invested. The key is thus to remain invested over a period of time so that the money compounds and the real benefit is visible to you as an investor.
 
Use of long term investing
Achieve difficult objectives
There are multiple times and reasons why you should adopt the strategy of long term investing. As a first time investor your goals and objectives might seem to be far away and difficult to achieve. This can seem within reach if there are regular investments for a long period time and the amount remains invested allowing it to compound. As the period increases your confidence in the process will also go up making you a better investor. Using mutual funds for this purpose will also suit your requirements as these provide a good option for first time investors.

Wealth accumulation
The goal of many people is to ensure that they have accumulated wealth for various purposes like children’s education or retirement planning and this is possible only when the long term investing approach is taken. Taking this view will enable you to slowly and steadily build your financial position and this will help in the accumulation process. A growing economy with a vibrant corporate sector will mean that there is a scope for appreciation in the value of the economy as a whole and you will be able to reap the benefits of such a situation by adopting a long term approach.

Easier to implement
It is also prudent to ensure that you make your goals long term in nature rather than wanting to do everything right now. This will make the process easier to achieve and you will be able to grow the amounts steadily as you accumulate the amounts in your investments. It will also save a lot of trouble in trying to get many things done in a short time period.

How should I tackle this situation?
A few simple steps should help you to navigate the path around your finances in a simple and easy manner. As a first time investor you would face a huge amount of choices and options regarding your investments and this might seem to be a tough area to tackle. The best way to tackle this would be to use mutual funds for investing as professional fund managers who devote their entire time to managing money can help your money grow over a period of time.

Taking a long term approach would be a better option of going about the investment process. Ensure that you are investing from a early period in your life as it gives you a longer time period to grow your money over your life.  Also invest consistently without any disruption in the process and this will be a way to build wealth over your life.

Apart from this there will be tough times when your investments might seem to be stuck and in many cases this might have declined a bit. If you are convinced of your investment choices then brave this period and stay invested because you will be able to ride out the storm and emerge stronger and better than before.  Ultimately you need to give yourself the chance in life to let your money compound and if you do this there is a better chance of success.

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