Do not be penny wise, pound foolish! How investors can ensure financial independence

Financial independence refers to a state where one has enough resources at disposal to meet expenses as well as fulfill future financial goals.

The first step to be taken on this journey is to stop procrastination. Different individuals will have different investment strategies as the goals (marriage, health, education, etc.) would vary, as would the time horizons and risk preferences.

One should research the fundamentals of an investment, cutting out unnecessary white noise, do own due diligence to make informed decisions, and never follow a herd approach.

One should also prepare for the base, best and worst-case scenarios along the investment horizon and adhere to it. This curbs emotional investing, irrational impulsive behavior, and any knee-jerk reactions.

One should not be swayed by exuberance, fear, or any aberrations. Volatility over the long run should not erode a substantial portion of the corpus.

Slashing expenses can be a good passive way to start paving the path to a well-thought-out portfolio – do not be penny-wise, pound-foolish.

This is in a way, equivalent to deciding whether an investment is over-valued and if yes, then decide to cut positions in it. As in the case of making an investment, cutting expenses also involves an understanding of the pros and cons at the nuts-and-bolts level.

One form of expense reduction could be debt trimming. One should nip existing debt in the bud, and try to avoid taking on more “bad debt” in the future. Examples of bad debt range from high-interest credit cards, to personal loans used for extravagant discretionary purchases.

One should always target reducing the most costly debt first as then interest expense would go down, thus freeing up more money. Not all debt is bad however and once again a sound cost-benefit analysis for taking on loans needs to be made.

For instance, taking on a home loan implies one could be a homeowner and the concerned property might appreciate in value significantly over the long run depending on the right market conditions and investment.

Starting early in this journey always has an advantage. One should make sufficient savings and investments in the early stages of one’s career.

The regular source of income could be used to build a corpus of funds that should take care of all our expenses and needs. Next, one needs to lay down one’s goals and its interpretations on one’s financial balance sheet. This sets us the target that our portfolio needs to reach over the long run, decided by the time-line of our milestone goals.

Depending on the combination of the worth of the future corpus needed to fulfill our goals and the time span required for the money to mature into that worth, one can then decide on the split-up of the investment pie.

For instance, if our goals are ambitious and/or the investment time horizon is short, one would have to add in potentially riskier investments, possibly like equity to achieve the targets.

As mentioned, risk of the portfolio increases leading to higher swings in volatility, and one may not be able to stomach such roller-coaster rides, thus leading to impulsive selling at lows or other emotional decisions.

Consequently, one should then step back, ponder and possibly reduce some of the ambitious elements of our goals: either the needs or the time horizon for reaching them.

One should never forget to keep a buffer of liquidity always at disposal to capitalize on any opportunity along the way or for any emergency situation so that the core corpus is never touched.

Any cash inflows can now be invested into this strategic asset allocation and rigorously stuck to. However, along the way, there would come opportunities where one could capitalize on mentioned instances by deviating away from strategic asset allocation.

This technique is called tactical asset allocation where one tactically strays away from strategic asset allocation to capture potential upside in the short term if attractive enough.

Once such an opportunity plays out, one should then again maintain discipline in rebalancing the corpus back to the strategic asset allocation.

Should an investment decision turn out to be wrong, one should not hesitate in biting the bullet and pulling the trigger?

It is better safe than sorry i.e. better to sit in cash in the worst case, rather than worry about the opportunity cost of not remaining invested in such a dubious asset.

The portfolio and its performance need to be reviewed periodically and that in turn, would depend on the investment horizon of each of the originally thought-out goals.

One should not be ultra-microscopic and review performance every minute unless of course one is a day-trader. Bottom-line is that the review frequency should be in sync with the concerned investment horizon.

The volatility of the portfolio should be seen in intervals matching the review frequency ideally and commensurate return ratios and metrics should be analyzed as well.

Changes to strategic and tactical asset allocation would no doubt have to be made on the basis of this review and such apt decisions should help one reach towards the ultimate goal of financial independence.

(The author is CIO, Validus Wealth)

Disclaimer: The views and investment tips expressed by experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.