By Gautam Kalia
As the tax filing season comes to an end, we hope you are smiling at a lower tax bill thanks to the investments you made last year. It is extremely important to invest because with mutual funds, you can opt for equity-linked savings scheme (ELSS) to marry your tax-saving and investment goals and save up to Rs. 46,350 in taxes.
MFs, including ELSS funds, give you the opportunity to invest across diverse asset classes and allow you to invest in a flexible manner via SIPs. But investing in mutual funds goes beyond just keeping the magic alive in your tax-statement. It also helps you score all your life goals. Here’s how you can set goals and achieve them through your investments.
Identify your goal
The first step is to recognize and define your goals according to your time horizon, risk appetite and liquidity needs. For example, your investment goals for money that you're saving for retirement may be very different from your goals for money that you're saving for a home down payment, a holiday or even an expensive gadget.
Know your time horizon
While setting your investment goals, the first thing that you need to ask yourself is “when will you need the money? For example, are you saving for a house you would like to buy in 5 years or a vacation that you are planning next year? This will have a significant impact on the type of asset class that you invest into such as equities or fixed income.
Know your risk appetite
Risk appetite is your tolerance to bear fluctuations in your invested value due to market movement (also called as volatility). Risk appetite depends on various factors such as your age, financial responsibilities, knowledge of financial markets, level of income, etc. Depending on your risk appetite for market volatility, you could be a conservative, moderate or aggressive investor.
A conservative investor will have the least appetite for volatility, while an aggressive investor will have the highest risk appetite. It is important to note that your time horizon will have an impact on your risk tolerance. For example, if you are investing for your retirement 30 years from now, you may be more willing to accept more risk for your investment in exchange for potential higher return. But you may not want a potential higher return for higher risk for your child’s education fund that you need in 4 years’ time.
Know your liquidity needs
Liquidity refers to the time it takes to convert your investments into cash or equivalent. For example, real estate can take a very long time to sell as against mutual funds units that can be redeemed within a period of 2-3 days. But you might suffer a loss if you need to sell when the market is down. Liquidity also affects your choice of asset class that you invest into. If you don’t have short term liquidity needs, you may consider investing in less liquid assets with a potential to earn higher returns as compared to liquid instruments. Liquidity is also impacted by other factors such as income stability, emergency cash reserve, financial obligations, etc.
Goal-based asset allocation
Once you are clear about your goals, you can just choose your asset allocation and align it with your goals. For instance, you can invest in liquid funds to meet short-term goals such as buying a new gadget or simply parking surplus funds for use after a month or two. Liquid funds invest in short-term money-market instruments such as commercial papers, certificates of deposit, treasury bills and allow you easy access to your money as well.
For medium-term goals, such as down payment for your home or vehicle, you can consider an asset allocation that is more skewed towards fixed income funds which invest in fixed income securities such as government securities or corporate bonds and debentures. If your risk appetite is higher, you can even consider balanced funds, which invest in both equity-oriented funds and debt-oriented funds. These funds provide you a combination of capital growth through exposure to equities as well as income stability through fixed income instruments.
For long-term goals, such as a child’s education or your retirement, you can consider investing in equity-oriented funds with some exposure to fixed income funds. Due to their return potential, equities are best suited to beat inflation over the long term. Within equity funds, you can choose equity funds with a large cap or mid and small cap stock orientation or even multi-cap funds that invest in stocks across market capitalizations. If your risk appetite is even higher, you can even consider sectoral or thematic funds.
Thus, as is evident, there are varied investment solutions for specific needs. All you need to do is choose the right schemes that are in sync with your financial goals.
Gautam Kalia is the Vice President and Head – Investment Products at Sharekhan by BNP Paribas. He has over 15 years of work experience in Investments and Wealth Management across India and the Middle East.