Browse Month: March 2017

Why I need diversification of investment?

Why do I need to diversify my investments?

Very often we come across the phrase “you must diversify your investments in order to save yourself from swinging markets” while going through personal finance articles or during a meeting with financial adviser.

I am new to personal finance. The term “Diversification of investment” sounds quite confusing to me. Why to make my life complicated, if I have a bagful of money, I should go and purchase high performing stock of XYZ LTD and be done with my investments, sit back, relax and enjoy my retirement years? Right?

diversification-of investment

 

I do not know what is diversification of investment?
Diversification of investment is a common practice where your investments are spread across different asset class such that your exposure to any one asset class is limited. In other words you are not dependent on only one asset class to give you returns. This saves you from extreme swings in your net-worth in case of any financial turmoil in the economy

 

Ok, understood. Now why do I need diversification in my portfolio? How it is going to help me?
If you are inclined to stocks for the kind of returns they generate and If you keep investing all your money in stocks then you run a risk of exposing yourself to the volatility of stock market. What if when you need a chunk of money and stock markets crash just when you are about to withdraw? Similarly if you like to play safe and invest all your money in fixed deposits then you are reducing the value of your investments as inflation will eat up your money gradually. Hence you need a balanced approach based on your investment horizon and your risk appetite. You need to arrive at an optimized combination where you are not dependent on one asset class and also you are beating inflation so that your overall wealth increases. Diversification of investment if exploited can help you in wealth creation which in turn will help you in racing towards financial independence.

 

Ok, now tell me what are my options for diversification?
Broadly speaking there are asset class like share market, Government bonds, bank deposit schemes, commodities, real estate.

  • Stocks give high returns but there is a high risk factor associated with stocks.
  • Bonds are safe, they have guaranteed returns but the returns are very low. It is difficult to beat inflation when you are invested in bonds. Also bonds come with lock in and not easy to liquidate.
  • Bank deposit schemes give different returns based on the tenure of investment and the product you invest in. They are easy to liquidate and can be used to park cash effectively.
  • Commodities like gold and silver do not appreciate much but they neither do depreciate. They are usually stable even during market crash and also very safe during economic meltdown and in warlike situation.
  • Real estate is a big ticket investment. It gives you good returns over a period of time. Also the biggest drawback is that you can not part liquidate the investment from this. Though through REIT it’s possible now but if you own a property you can not part sell it.

Based on your risk appetite, you should gradually diversify your investment across all classes mentioned above. There are mutual funds that comes in all sizes and covering all asset classes which you can choose to invest your money. But you need to study a little in order to get yourself acquainted with the asset classes and mutual funds. This is not a rocket science but a study will help you to make an informed decision.

 

I am a conservative investor. How can I take benefit of diversification?
If you are a conservative investor, still you have to plan your investments such that you beat inflation which is the biggest killer of your money. As a conservative investor you need to pick the mix of Bank deposits, bond funds, debt funds based on the tenure of the individual investment. Also you will need a certain exposure to stock market so that you can beat inflation. This can be achieved through investing in balanced mutual funds or a small exposure to diversified equity funds. You can have a folio where you invest 80% in bond funds/ bank deposits / debt funds and remaining 20% in diversified mutual funds. Diversified mutual funds will reduce your risk by investing in a range of stocks across sectors and will give you returns which will make your overall folio beat inflation (hopefully)

 

I am an aggressive investor. How do I diversify?
Being an aggressive investor you should focus on generating maximum returns. Also at the same time you should be careful enough that you do not lose money during economic meltdown or stock market crash. You can have a good 60% – 80% investment in stock market and 20% – 40% investments in bond / debt funds / commodities. Here again mutual funds can help you as within stock investment you can further diversify by investing in diversified equity funds, sectoral funds like banking funds, pharma funds, infrastructure funds etc. You can also use mutual funds as vehicle to invest in bonds and debt funds. This will reduce your risk from exposure to uncertainty of stock markets.

 

Ok, all this is fine but what are major concerns with diversification?
The biggest concern with diversification is “over diversification”. It’s human tendency to worry a lot. If as an investor you worry a lot and over diversify yourself by investing across all asset classes with investments in too many sub-classes like all sectors covered by buying top 10 stocks from them. This will create a huge portfolio which will be difficult to manage over time. And also it is difficult to study each sector and re-balance portfolio if you have too many stocks with you. Also there is a cost associated with buying and selling calls each time you execute. Hence it is always advisable to keep the diversification to a level where you can manage it profitably.

 

To Sum up the diversification of investment
There is no generic diversification formula which you can apply to your investments and run your investments on autopilot mode. There are dependencies on time horizon of investment, risk appetite, investment goals, your knowledge about investment and your experience in the investments. All put together, it’s always better you yourself arrive at the diversification distribution of the asset class for your portfolio.

But one thing is sure, if you diversify well based on your risk appetite you can be sure to create wealth over a period of time and you can cut down the risks of wealth erosion due to economic meltdown or share market swings. This balanced approach will also help you in achieving financial independence quickly.

Happy Investing !!!

Accelerate your NETWORTH , Here’s HOW?

Here is a post on How to accelerate your Net Worth & achieve Financial Independence. Increase in net worth will accelerate your journey towards Financial Independence

Net-worth gives a clear measure of your wealth. In accounting terminology, net worth is really everything you own of significance (your assets) minus what you owe in debts (your liabilities)”. Assets include cash and investments, your home and other real estate, cars or anything else of value you own.

 

how to increasse networth

 

Now when it is clear what is net worth, I am sure you would want it to keep growing at a healthy rate. A healthy growth rate in net worth will give you a confidence in your life with respect to your finances.

Here are some of the methods I am listing down which can accelerate growth in your net worth. All these steps are simple and you can implement them in your financial plan to stay on top of your finances and off course net worth.

 

  • Work towards paying all debts.
    Kill the debt with highest interest first. Usually the personal loan which we take for some holidays or some family function carry the highest interest rate. Same is with the credit card debt. Make sure that you get rid of personal loan and credit card debt. Then focus on getting rid of consumer loan which you took for buying that 85 inch cool TV, auto loan for your cool SUV. The EMI on these loans might look small but if you do that math you end up paying a lot in interest on them. Remember the price you pay for any item bought on these loans are the cost of principal plus the cost of interest. Once you are done with all high interest loans, target home loan. Yes, though you get benefit on home loan but a loan is a loan. The feeling of having freedom with no loan is something out of the world.

  • Increase your contribution towards the Employee provident fund.
    If you do not have PF – Provident fund account with your company, open a PPF account with any public sector bank and max-out the limit of yearly deposit in the first month of every financial year. These account ensures that over a long run, you accumulate enough corpus which can help you plan your retirement years they way you want.

  • Make a budget.
    This article details on how to make a basic working budget. Once budget is made, trim your unwanted expenses. Remember you will not be able to trim your unwanted expenses unless you make a budget. Be on top of your expenses and cut down all unnecessary expenses.

  • Do not let your extra cash sitting idle in low interest savings account.
    If you have huge amount sitting idle in savings account, it is losing its value. Currently savings account give only 2%-3% interest. And the inflation is 6%-7% which means your money is losing its value. Immediately put your money to work harder through mutual funds, sweep in deposits, fixed deposits, stock market based on your risk appetite. The returns in these investment streams are higher than the regular savings account and money in them ensures that you are beating inflation and not losing value of your money.

  • Start building a mutual fund portfolio.
    This is from long term perspective and invest into this through systematic investment plans across a diversified range of mutual funds consisting of diversified equity funds, balanced funds, large caps, mid caps. This does not need expertise, it only requires basic knowledge which is available freely on the internet.

  • Reinvest all the income generated from your investments.
    Do not blow away the gains from your investments. If you keep re-investing, it will help in increasing your investment corpus considerable and that too quickly. Also this exercise of yours coupled with the brilliance of compound interesting will accelerate your net worth growth.

  • Invest a fixed amount regularly, every month.
    Pay yourself first – this should be the mantra. Automate your investments. Suppose you receive your salary in the first week of the month, keep your systematic investment plan SIPs automated for the first week of every month. This will ensure that you keep investing every month without a break. Remember – the one who invests regularly and over a long duration reaps the benefits.

  • Invest all the windfalls you get. Do not splurge.
    Gifts and inheritance money can be very helpful in accelerating your net worth.  Remember more money you put in investment, more your investment corpus would be and more money it will generate.

  • Do not go crazy about new vehicles every few years.
    Remember that vehicles are merely an instruments for going from point A to point B. Also remember there is a huge cost associated with the new vehicles in terms of insurance, maintenance, running cost etc. And it is a fact that a vehicle loses about 20%-25% of its value the moment it comes out of the showroom and it is a depreciating asset.

  • Do not accumulate loans to purchase stuff.
    Every new loan you take is a liability and is a hindrance in your plan to financial independence. Every new EMI / monthly payment added to your monthly income will surely decelerate the net worth growth.

If you follow the above listed steps diligently and track your progress, I am sure you will see a positive movement in your net worth. You need to improve, evolve your approach constantly in order to see your net worth moving northward. Each one of us has different lifestyle, different expenses but what is discussed in this article are basic building blocks to improve your net worth.

Improvement in net worth will result in creating wealth and early financial independence. Don’t you want the same?

Making a simple budget to improve your personal finances

 

Making a simple budget to improve your finances. This is an important step in reaching your financial goals and financial independence

I am sure there will be many among us who have never actually attempted to make a budget or even noted down their expenses on a daily basis. Many of us would have never experienced the need to see all their income and expenses in one single sheet – which is more due to negligence than lack of knowledge.

How to make a household budget

 

 

Why budgeting is important?
All large companies and organizations do their budgeting, write their expenses, do regular audits in order to see if their actual spend is as per the budget or not. They hire specialists to do this job as they want to prevent any money leak and also they want to be on top of their expenses so that they don’t lose money in a big way.

 

How about budgeting at my personal level?
At personal level, we do not need the kind of skill level that corporations employ to do budgeting, but a basic work on spreadsheet which is not too much time consuming is enough. This is just to have a quick access to your financial status at any given day and to plan any expense which is not a regular one like purchase of a new car, or a foreign holiday.

 

I don’t have knowledge of accounting software / tools required to do budgeting
No worries. For keeping track of personal expenses and basic month on month budgeting, you need to be an expert in using accounting software or tools. As this is Information Technology era and all of us are well versed with MS office (MS excel to be more precise), which is more than enough to do the designated task of budgeting.

 

What do I need to do with MS excel?
First make a list of all your spend in a month. For starters, make four columns in the excel sheet.

  • First one should have the date of expense
  • Second should have the place where you spent the money
  • Third should have the amount you spent
  • Fourth one should be the category of expense (classification as food, grocery, housing etc)

 

how to make budget in excel

 

Every single expense, I repeat every single expense you incur should go in this excel sheet. Why? You need data. This data will make foundation of your budget. And the data accumulated over few months will give you enough food to analyze your spending pattern and believe me; it will help you save tons of money.

At the end of the month, sum up all. You will be amazed to see how much you spend, when there is no budget for expenses.

Now – sort these expenses by category. Sum up the money you spent in each category. This category wise spend will be the backbone of your budget for the next month.

Easy so far? Isn’t it?

Now make a new spreadsheet which will be the budget for your next month. Keep four columns in this sheet.

  • First is category name (housing, food & groceries, fuel etc)
  • Second is what I spent on category last month
  • Third is what I intend to spend in this month on the category
  • Fourth is how much I actually spent on the category (this will be filled once the month gets over)

budget summary - household

 

So many things to do? This looks little tough for me. Do I need to carry this exercise every month?
This might look little tough as you are not used to of doing this. Only the first cycle would take time, then it’s a kind of a cake walk. Once you have completed one cycle, format is ready. You only need to enter the data from month 2 onward.

Ok got it. Now how is it going to help me save money?
If you are making your budget for the first time, there are good chances that your spending is more than your income otherwise you would not be taking pains to make the budget. Once you have data for a few months – say three months you can see and analyze the expenses you have incurred in each category. If you are spending way too much on eating out or buying cloths, it would be clearly visible in the category expenses figures. You can dig a little deeper to check and see if you can trim these high spend category expenses which are not required for survival or which are mostly want related expenses.

Armed with the data of few months, you can repeat the exercise of trimming the unwanted expenses. The money which gets generated from cutting down unwanted expenses will improve your cash flow and will give you an opportunity to invest this money in order to generate higher net worth. This higher net worth in turn will lead you to financial independence at a quicker pace. Wealth creation is all about the art of increasing the gap between your income and expenses and keep investing the difference across the investment spectrum to generate higher and stable returns.

Budget is one of the major steps in road to financial independence. If you master the art then you can be assured of sealing the money leaks in your month on month expenses.

Supermarkets are a big TRAP

Why Supermarkets are a big TRAP and also big money DRAIN !!!

All the supermarkets are intelligently designed. What item will come where and in which row is meticulously planned. No wonder why the retail chains hire MBA grads for such a higher salary. The planners sit in a plush meeting rooms, peeping at the historical data and planning how to fit certain useless high margin items in front row of the stores.

Supermarket are money drain

 

The layout Trap

The layout of supermarkets are organized in such a way that daily use items are always found at the farthest place from the entrance. Once you enter to buy your supply of bread or milk, you need to wade through the entire store with each shelf literally shouting the offers to you – on useless items. And being a ‘good buyer’ we always end up picking a couple of useless products because of some stupid offers on them.

It is easy to avoid the TRAP

It is not that there is no way to avoid this trap. Impulse buying can be tackled tactfully by visiting these super markets with a written buying list of items you intend to buy. And you must stick to this ‘buying list’. The buying list is something that requires a little bit of effort from your end to make. This is in order to keep your list as efficient as possible.

Do keep the following points in mind for preparing an efficient buying list.

  • Plan main grocery shopping trip only once or twice in a month. This applies to the items like flour, pulses, rice, cooking oil, spices, supplies like sugar, tea powder, coffee powder, cheese, sauces etc. Estimate the quantity you would require of these supplies and enter them in your beginning of the month main shopping list. At the most when you enter the super market, you can strictly look at the offers on the items in this list and weigh them by arriving at per unit cost of item – with discount and without discount. Take whichever is the cheapest BUT the price point – with discount should justify the quantity you are buying. Use common sense; do not buy 25 Kilograms of sugar just because you get 10% discount on buying 25 kilograms pack when your monthly requirement is only 2 kilograms of sugar.
  • Reserve a weekly visit just to buy the stuff which is perishable and you need their supply often. This is for the products like eggs, milk, paneer, curd, juices, yogurt etc. You cannot stock these items for long at home and they are always better if consumed fresh as they come with a short shelf life. You can include your weekly bread supply too in this list. Go to the supermarket on a weekend, check offers on these products and purchase them. Here again use common sense when you are comparing discounted price with the quantity.
  • Add items from your main shopping list into the weekly list for which you are low on supply. For example, if you have some unexpected visitors at home for a few days, you are sure to go low on the supply of cooking oil, wheat flour, rice, sugar etc. Do not go separately to buy these items on a weekday. This is waste of time, fuel and energy. Instead, add the low stock items in the weekly shopping list and buy them on a weekend. Since weekends always have some discounts running to attract buyers, a chance of you getting a better price is always there.
  • Take review of the stock levels once in 15 days and again add items which are low in quantity in the weekly shopping list. Here again it should not be the case that you have monthly rice consumption of 5 kilograms and in spite of having 10 kilograms in stock you have gone ahead – added the item in the monthly shopping list and bought another 10 kilograms just because there was an offer running on the item.
  • NEVER ever enter any super market for shopping with empty stomach. When you are empty stomach, your hungry stomach guides you through the fast food stuff and compels you to buy stuff like cakes, pastries, ice creams, snack items. Your hunger makes you succumb to buy sandwiches and pizzas thus killing the purpose of entering the super market to buy grocery items and save money by buying your monthly requirements in one visit.

Super stores play mind games with people. Armed with the data and analytics, coupled with brainstorming of grade A pass outs from business schools, they literally direct you on what item to place in your shopping basket. You need to be a little smart and systematic to dodge the useless offers thrown at you when you enter a super market and only buy the items you need to buy.

A visit to the supermarket for grocery shopping could turn a big money drain and destabilize your budget for the month if not planned carefully. Over a period of time, these visits have potential to derail your financial planning and can make a big dent in your wealth creation plans.