Expert advice

Nov 20, 2014,18.53 IST

You need an open mind to invest and achieve goals

Suresh Sadagopan
Ladder7 Financial Advisories

He likes it. He likes it not. She likes it. She likes it not.

Are we talking here about a lovelorn soul, second guessing whether the object of their affection loves them or not? No, we are not.

We are discussing about whether someone likes investing in a particular asset class – say, equities! There are some who like it and some who don’t.

Again, attraction to a particular asset class is also mostly a factor of past experience. If one has had very good experience in investing in properties, one would be positively inclined towards  that asset class… some may swear by it and would not even want to consider any other asset class for investments.  There are others who have been singed once by  an asset class and after that had decided never to touch it again – even if they know that they had speculated and that is why they lost badly!

That is the classic behavioural aspect of people... reason why investors’ portfolios are seldom balanced.

Understanding asset classes – It is important to have a portfolio which has a mix of different asset classes.  They have different attributes and would contribute towards getting to a stable portfolio. Let’s understand their characteristics.

Equity  -  Investors have a love-hate relationship with equity… but there is nothing good or bad about equity. Equity shares are a fractional ownership of a business itself. Hence, it is right for investors to evaluate what they are investing in.  

Also, the investment into the business through equity ( remember, through equity one owns a small share of the business )should be held for long. No one invests in business to sell in fifteen day or three months, do they?

But, that is the theory. In practice, equity investments are done because a friend recommended it,  broker assured that it will double in six months etc. No wonder that there are many who hate equity as opposed to ones who like it. Retail participation in the country is some 2%!

There is an element of risk in equity investing in that even the capital invested is not protected, returns are not assured, there is a possibility of holding dud shares which don’t trade etc.  However, equity investments chosen after due diligence, would provide good returns over time. Infact, equity is one asset class which has the potential to offer a decent real return, after adjusting for inflation. What’s more, equity or equity oriented assets are not taxed if they are held on for 12 months or more. So, equity offers many conspicuous advantages.

But equity is a longterm instrument. Any punting on it can unravel badly, even for market mavens.

Mutual funds –  When Mutual funds ( MF) are discussed, it is assumed to be equity funds. One cannot be more wrong. Infact, 75% of assets in the MF industry assets are in debt funds!

Mutual funds are schemes where retail investors’ money are collectively invested and has the professional oversight of a fund manager. The fund manager manages the money based on a mandate given and endeavours to generate superior returns as compared to the chosen index as well as the corresponding category.

Retail investors may not have the wherewithal to pick and choose equity shares. Such people would be best served by investing through MF schemes, which are professionally managed and the returns, after the agreed charges are shared with investors.
There are different kinds of equity funds to cater to the requirements of various investors. Equity MF Schemes ( which have atleast 65% investments in Indian equity traded in registered Indian stock exchanges ) enjoy the same tax benefits as Equity shares.

There are debt MF schemes to invest in for durations, from a few days to a few years.  These funds can be invested in based on the tenure, risk-return expectation etc. Even Debt MF schemes are subject to volatility as the underlying instruments are traded securities. But, it would not be as volatile as equity assets. Debt MF is subject to ST capital gains taxation till 36 months, which is at one’s income tax slab rate. Beyond 36 months it is long-term capital gains taxation treatment and one could take advantage of indexation.

Then there are hybrid funds, which can be equity oriented or debt oriented. This could work for those who want to moderate the risks they are taking and also want a bit of non-correlated assets to get stability.

Other debt instruments -  There are bank FDs, which are clear favourites as it is easy to understand and offers moderate, but stable  returns at low risk. Company FDs are higher on the risk quotient, but could offer better returns.  Investors need to check the ratings which is a measure of how secure is it to invest in a company. This is a reasonably good measure only – not fool proof one, as rating agencies are remunerated by the companies they rate!

Tax free bonds were available till last year. This was useful for those in the higher tax brackets as the returns which was available was not subjected to tax. Also, they offer sustained returns over a long period like 10 -20 years, which is very useful due to it’s predictable cashflows.

PPF is another instrument which offers good tax-free returns, over a long period.  One can invest upto Rs.1.5 Lakhs in one account.

Property -  Property investments are for self use or to generate returns.  It has become easy to acquire properties on one hand due to the easy availability of loans; on the other, it has also become difficult, as the property prices have gone to stratospheric levels, especially in major cities. Also, the property market is chaotic, with little regulation and investors are at the mercy of the builders.  Titles are not clear in many cases and investors can get stuck. Properties can be encroached upon, which would involve years of legal wrangles. Also, property usually involves bushels of black money.

Properties do offer appreciation potential, but the property market remains underdeveloped, lacks depth and price discovery is poor. Properties again can offer rents; but rental yields for residential properties are just 2-3% of the prevailing property price. This essentially puts the onus of investment returns on a property to value appreciation of the asset itself.
An asset class that needs to be considered with circumspection… but is being embraced by investors like it is manna from heaven!

Gold – Like property, Gold has a primordial allure. Along with property, gold was an asset class used in the centuries gone by. Gold does not have any real use except for ornamentation. It can never give returns like shares do by way of dividends or properties do by way of rentals. There are much better instruments available today and yet people are stuck in the middle ages!

Gold is a good hedge though, to have as a part of the portfolio. However, Gold need not necessarily be invested in physical form and can be more conveniently invested through an ETF. Gold ETF also lowers the cost of acquisition and carry.

Who should invest in what? For someone starting off in life, the important first step is to set up a liquidity margin. This can be done through money in the Savings account / liquid funds.  In the beginning there may be many expenses but limited income.  Such people should also start some savings on a monthly basis, to achieve various short term goals. For instance, to buy a TV, one could save Rs.3,000 pm for 12 months and could buy one at the end of that period, rather than flashing the plastic!

The newly employed can also start putting aside some money for long-term goals like retirement – it may be small, but could still be a good beginning on the road to retirement funding. Equity investments or Equity oriented MFs are suggested for this purpose.

Once married and with kids, regular investments on a monthly basis to take care of various medium and long-term goals become necessary. Here it can be a mix of equity and debt instruments, with equity clearly holding the upper hand.  Regular PPF contributions should start at this stage.

In the middle, @38 – 50 years, the investment pace needs to be ramped up.  Hopefully, one would be earning much more than one spends. This would be the peak period in one’s career and should be used to full advantage to set oneself up, for a comfortable future.  

EMIs should be handled with care. Loans taken for properties for self-consumption and investment should be closed in this period ideally. Over leverage in property should be avoided.  Bonus or any other inflows can be used to retire loans.

Equity investments can be above 50% in this period. Going into the age bracket of 50-60, equity investment can gradually be toned down.  It could come to just about 40% at the time of retirement @60. During the run up to retirement, loans have to be whittled down or closed without delay. Proper evaluation of finances available needs to be carried out and a check needs to be done to ensure preparedness for retirement.

Beyond 60, the corpus needs to be set up for regular income. It could be a combination of FDs, Senior citizen saving scheme, Tax free bonds, debt MF schemes, Equity MFs, pension funds etc. In some cases, it could also be property which offers rental income.

Conclusion- One should not have fixations about asset classes and be prepared to invest in an appropriate basket of securities as per the dictates of the life cycle. Never invest just to save tax – it should always be for meeting a goal. If tax is saved in the process, it is even better.

One needn’t  have to like an asset to invest in it. It just has to be suitable. Professional help may be availed of, as necessary. One could do the due diligence and manage on one’s own too. As for the investment assets, one should go as per the dictates of what would be suitable, during that lifecycle.

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