Lessons to learn in personal finance
A mix of equity and bank deposits can add to heft to your investment portfolio
Most people in the lower income group want to start working even at the risk of contracting COVID-19. There are lessons to learn from this. In this article, we discuss why you could experience a similar risky attitude with your goal-based portfolios and how to moderate the same.
Also read: RBI Governor Shaktikanta Das meets heads of banks, reviews economic situation
Do you invest in bank deposits and gold? Specifically, do you avoid equity investments because you consider them risky? Then, there is a cause for concern. Why?
Picture this. You need ₹1.5 crore in 10 years to finance your child’s college education. You invest in bank deposits and gold to achieve this goal.
Two years before your child has to enter college, you realise that given the actual returns, your investments will fall short of funding your child’s education.
What will you do? Because you cannot postpone the goal, it is highly likely that you will make risky investments to bridge the shortfall. Or you may be forced to borrow at a high interest rate. So, what should you do to moderate the possibility of having to take high risk to bridge a shortfall?
You know that the expected return on equity is higher than that on bank deposits. So, if you invest in equity along with bank deposits, you can expect to accumulate more in your investment portfolio for the same amount of savings.
But that is easier said than done. Bank deposits offer certainty in cash flows. You know today, the value of your deposit at maturity. You want to avoid equity because of the uncertainty in the investment outcome. Yet, you willingly take high risk at the end when faced with a confirmed shortfall in your investment portfolio!
To overcome your fear of investing in equity and at the same time reduce the possibility of having to take high risk, set up a forward systematic investment plan (SIP) on an equity fund at least a month before your annual salary raise.
For instance, set up an SIP in April that will start in May (the month of salary raise) with savings from the incremental salary. Why? For one, it is easy to risk your savings you do not have as yet! For another, you are not cutting your current living standards to save more. Importantly, if your investments are profitable, you may not have to make risky choices towards the end of the time horizon for your life goal.
Given the current scenario, you may not get a salary raise immediately. But, if you realise how your attitude of taking risk can change, you should be on course to setting up forward SIPs when you expect a salary raise.
What if you experience negative returns on your equity investments? You will then have to borrow to bridge the shortfall which you will anyway do if you were not invested in equity!
Yet, there is a good chance that your equity investments will perform well, and you may not have to take high risk at the end to achieve your life goal.
So, do you want to take high risk at the end in an attempt to bridge a confirmed shortfall in your portfolio? Or, do you want to invest in equity, hoping to achieve your goal without having to take higher risk at the end? The choice is yours.
(The author offers training programmes for individuals to manage their personal investments)
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