The starting point for achieving financial independence begins with
a financial plan. Determine your current financial position, available
resources and immediate fund requirements. Then set your long term
financial goals: keep in mind your risk-taking ability, current
lifestyle, occupational profile and family background. The number of
dependents and their own financial status –a working spouse gives you a
greater degree of financial freedom- should also be considered.
A
financial plan helps an investor to lay out realistic goals and then
work towards them over a period of time. Since each individual has a
unique setup, this section only makes broad recommendations that should
apply to everyone before embarking upon an investment programme.
Estimate short term needs
Many
investors plunge into the stock market without assessing their short
term fund needs. Faced with a crunch, they end up selling shares much
earlier or book losses at the smallest sign of trouble. That clashes
with the fact that the holding period in equities is crucial to meet
the targeted return. By estimating short term needs and preparing for
them, the painful decision of selling shares before time can be
avoided.
Create an emergency fund
Emergencies
happen when least expected, forcing you to alter your investment plan.
Therefore, having a cash reserve to help meet situations like a medical
emergency or a layoff, ensure that your fund requirements are met
without affecting the investment plan. A cash reserve (money market
funds, which can be easily converted into cash should do) of at least
six months worth of living expenses or a medical or disability
insurance is a must.
Repay debt
Increase your net
worth by repaying debt. Start by repaying the most expensive debt –
usually credit card debts and unsecured personal loans are the most
expensive. Keep some amount of debt, especially if you get a tax
benefit, like on housing loans. If the return on investment is greater
than the amount of interest paid on debt, invest. But if the
risk-adjusted return is still less than the amount of interest being
paid on the loan, you are obviously better off clearing the loan.
Set priorities in a chronological order
Classify
your own priorities and that of your family members based on their time
of occurrence. For instance, paying a lump sum donation for getting
admission to school is a more immediate need, than providing for higher
education. College education is still years away compared to school.
Thus, school education can be provided for by investing in fixed income
instruments like short term bonds or fixed maturity plans of mutual
funds. For college education, a mix of equity and debt, with more in
equity, can be taken to combat inflation and the higher risk is spread
across a number of years.
Practice Asset Allocation
No
investment plan is complete without an asset allocation. Different
types of assets exist; the most common ones are cash and bullion, the
most liquid asset class. Then, there are fixed income instruments, like
bonds and fixed deposits, which are less risky, but yield lower returns
compared to equities, and are less liquid too. Mutual funds come next,
their risk profile depends on the type of fund –equity or debt or
balanced and the investment philosophy. Sector-focused funds, for
example, will be less riskier compared to diversified funds. Equities
are the most aggressive investment option, with high returns and
commensurate risk too.
Since there are various levels of risk
associated with various assets, it makes sense to identify your own
risk-return profile and then build an asset allocation strategy. There
is no ideal asset allocation, a one size fits all plan. You have to
make a plan that suits you best, allocating weights to various asset
classes and then designing an investment plan accordingly.
After
designing an asset plan, it is imperative to monitor it to ensure that
changes in asset prices have not skewed your allocation. A sharp rise
in equities, for example, may increase your exposure to equities, much
more than you may want. So, selling down equities and increasing
exposure to debt would be the right thing to do. |