There are several things to know before investing that you should be careful about. Deploying your hard-earned money in investments is always a welcome idea to build sizable wealth for the future. However, a few basic aspects should always be kept in mind before you start your investment journey. These are outlined below for your benefit.
Factors to Consider When Making Investment Decisions
- Create A Budget for Your Household
The very first step that you should follow is to set a clear budget for your household. This will help you find the amount that you have in your hands as surplus post accounting for your overall income and expenditure. Proper budgeting will necessitate listing down all the income sources and this should include salary/business income of you and your spouse, any interest on your deposits, earnings from investments, dividends, rental income and so on. Thereafter, list down all your monthly expenses and allocate money for each head.
This will include your investment outgo, loan EMIs and other debt, utility bills, groceries, fuel, phone bills and so on. Break down your half-yearly, quarterly and annual expenditure and income into a monthly model. Once you start following this budget, it will help you plan out your finances better. You will start seeing spending patterns in a few months which will give you all information about where you can save more. This will naturally help you make plans for reaching financial goals like vacations, higher education of children, buying a car and so on. The rule of thumb to be followed here is the 50:20:30 allocation model, i.e. 50% of income for living expenditure, 20% for savings and 30% for spending including food, travel, outings and so on.
- Cut Down on Debt
Before you check out viable investment options in India, make it a point to reduce debt as much as possible. Have a blueprint in place for doing away with debt as early as possible. If investors manage to notch up returns of approximately 12% per annum from their investments but pay the same amount in interest for a loan, the net result will not help in building savings/wealth for the future. Credit card debt, car loans and personal loans are not constructive loans while home loans are constructive since they help you build an asset while saving on taxes simultaneously. Home loan interest rates are considerably lower between 8.5-9% on an average while personal loans may require the interest of anywhere between 12-18% per annum. Credit card interest on the outstanding balance post roll-over could hover between 36-48% per annum as well.
You should first cut out debt which will eat into your overall investment returns. Suitably using debt will help you build a good credit history as well for needs in the future. Obtain your credit report and check the CIBIL score accordingly. You will have to improve the same if you need to borrow money in the future. Have a home loan where monthly EMIs will be a maximum of 40% of the net take-home income. This will help you cover other long-term commitments without any hassles.
- Have Proper Safeguards in Place
Prior to investing, ensure that your current assets are well protected through insurance, including your house and car. Also, make sure that you have health insurance to cover future medical expenses. Hospitalization due to an illness or accident may be required suddenly and can eat hugely into your savings. Stay protected with the right insurance plan and have life insurance coverage for your family members as well.
A term insurance policy and health insurance policy are indispensable while you should have adequate home and car insurance as well. Make sure that you obtain life coverage which is 7 times of your annual earnings. Add costs of covering long-term financial goals for covering additional risks. Insure yourself until you have financial dependents.
- Build Your Emergency Fund
You should not start investing for long-term objectives until you have an emergency fund at hand. Situations which classify as emergencies never arrive with proper warning and may include loss of income/employment, sudden disability on a temporary basis or other expenses which were not factored into the plan. Even a medical emergency may arise in a scenario where the claim is taking a long time to be processed or there is a waiting period for the disease in question. These situations require you to arrange money urgently for tiding over the circumstances. If you do not have an emergency fund, you may have to pledge assets as collateral for getting loans or take on costlier personal loans and other debt accordingly. You may even have to borrow from your family members or friends. Sometimes people may have to break existing investments as well. This will jeopardize long-term financial goals for which the funds were allocated in the first place.
As a result, build your emergency fund beforehand, keeping household expenses for at least 3-6 months in the same. This amount will give you financial stability and confidence for taking care of any financial emergencies in the family. Keep the funds in assets which are of a liquid nature. You may have some portion in a savings bank account with another in a sweep-in FD. Another portion may be earmarked for liquid or short-term mutual funds as well.
- Create Plans for Achieving Financial Goals
You should always plan out the financial goals that you have before investing. A planned investment module will help you effectively optimize resources at hand. You should clearly identify your life goals before starting to save for the same. Have separate investment plans in place for accomplishing each of these life goals accordingly.
Financial plans come first and then you should take into account factors like how and where to allocate specific investment assets, risk profiles and horizon/timeline for investments.
- Assess Your Tolerance/Appetite for Risks
Tolerance levels may differ for risks depending on several factors like financial situation/circumstances, age, goals and priorities in life and so on. If you are relatively younger and have a stable source of income, you may be more inclined towards investing in high-risk options although as you grow older, you may not be willing to take on as many risks accordingly. The risk appetite may be at its lowest just before or at the time of retirement when you will no longer have a primary income to support your investments.
Work out your financial position and your tolerance for risks likewise. Various investment options can be chosen on the basis of your own risk profile. Those with a higher appetite for risks can invest in mutual funds, stocks and real estate and those with conservative approaches towards risks may invest in PPF, FDs (fixed deposits), Government bonds and the like.
- Learn Basic Aspects of Investing
You should always endeavor to learn about the basic aspects of investing your money. Learn what bonds, stocks, mutual funds and other investment avenues entail and terms like volatility, liquidity and diversification. You need not become a specialist overnight; just basic understanding of investment terms and methodologies will do along with an overview of the market.
Make sure that these 7 things are taken care of before you start your investment journey.