Invest early to reap benefits of compounding

Before you start the investment process, always keep in mind two important parameters – time horizon and a target, advises Hemant Rustagi, CEO, Wiseinvest Advisors. While setting a target for a long term time horizon, inflation should always be taken into account.

“When you start investing early, the point is that you get long term horizon. You can invest in a lesser class like equity, which has a potential to do very well over long term time horizon. You can also benefit from the power of compounding,” he added. Below is an edited transcript of his interview. Also watch the accompanying video. Q: An investor can invest Rs 8 lakh as lump sum, how should he allocate his money? He has insurance cover of close to around Rs 30 lakh which covers him and his family. He has home insurance as well. A: Let me begin with the investor’s cover of about Rs 30 lakh. The thumb rule for insurance is it should be around 10 times your annual income. As far as your investment ideas are concerned, the key factor here is that you have a time horizon of two years. This is not a time horizon where one can take lot of risk because if one looks at equities, one needs a time horizon of at least 3-5 years. He expects a return of around 12-15% post tax. Equities, as an asset class, gives you tax free return. But since the time horizon is two years, I would not recommend going into that. At best, you can have some exposure to equities. So I would recommend a combination of a couple of kind of funds. One is debt oriented hybrid funds. These are typically monthly income plans. These monthly income plans have two options; you have monthly dividend as the name suggests and the second option is growth option. These schemes typically invest around 80% in debt and 20% in equity. Since the equity exposure is capped, even if the markets are doing well and the exposure becomes higher, the fund manager would invariably book profit and bring it back to the original asset allocation. So since he has a lump sum money of around Rs 8 lakh, he can look at two monthly income plans, HDFC MIP Long Term and Reliance MIP and the third fund can be either short term debt fund for a two year time horizon or fixed maturity plans (FMP). This is still a time where you can look at fixed maturity but as the interest rate goes down the FMPs will not remain that attractive. Currently, FMP can also be a good option. So, a combination of debt oriented hybrid funds and a debt fund, either short term or a FMP. As far as equities are concerned, the key factor here is the time horizon. If you do not have flexibility in the time horizon however attractive the level may be today, even if you feel there are some factors which can turn market into a positive one, it is not advisable to go 100% into equity. If you go into a debt oriented hybrid fund, at least 20% of your money will go into equity but investing 100% into equity for a time horizon of 2 years is not advisable. Q: How should an investor allocate his money if he can invest Rs 2000 per month. He has an investment of Rs 2000 per month. He wants to invest consistently for 20 years. A: When you start investing early, the point is that you get long term horizon. In this case for example, he has around 20 years and then he can invest in a lesser class like equity, which has a potential to do very well over this kind of time horizon. He can also benefit from the power of compounding. So it always makes sense to start to investing early. A couple of things that need to be done before the investment process begins; one is to establish a time horizon. The second is to establish a target. A target is very important because when you talk about an important goal like child education and for a time horizon of 20 years, inflation has to be taken into account. If the kind of education that he wants to give it to his daughter will cost Rs 10 lakh today, if I take 6%inflation for the next 20 years then the cost will be around Rs 32 lakh. So it’s very important to take inflation into account and then start planning. For a 20 year time horizon, investing in equity fund through SIP would be the best option. What he can look at basically are two well diversified equity funds. One is HDFC Top 200 and second one is Canara Robeco Equity Diversified. But if the target is around Rs 32 lakh, he would need to make an investment of around Rs 3000 per month. If he is not in a position to do that, he should begin with Rs 2000 and see wherever in future it is possible he should try and increase that amount to achieve his goal.