Advertisement

Help
You are here: Rediff Home » India » Get Ahead » Money » Invest
Search:  Rediff.com The Web
Advertisement
  Discuss this Article   |      Email this Article   |      Print this Article

Watch your money grow!
Rachna C
Get news updates:What's this?
Advertisement
September 08, 2005

I was recently chatting with my friend Manmeet.

He is of the firm opinion that he should invest only in equity (shares and mutual funds that invest in shares).

ImageForget about fixed deposits, post office schemes, bonds and other such investments (such fixed return investments are referred to as debt investments). 

His logic: you get the best return in equity, so why concern yourself with the rest?

If that is what you are thinking too, hang on. Investment planning is not just about great returns but also balance and safety.

Here's a quick primer on how you should invest your money.

The bull run has clouded everyone's judgement

No one is denying the fact that some have made millions in this bull run. Even some equity funds (mutual funds that invest in the shares of companies) have delivered exceptional returns, in excess of 100% in a year (a fact Manmeet kept harping on!).

But what people tend to forget is that the equity market is experiencing the most phenomenal bull run in Indian history. 

And, since the returns of equity funds depend upon how the equity markets have been performing, they too are going great guns.

What if this changes? It is bound to happen; even if no one knows when.

Go back a few years to the stock market crash in 2000; you will understand the risk involved with investment in equities.

I am not denying that equities are not the best performing asset class over the years and they could make you a great deal of money. All I am saying it that all your money should not go into it.

Why a balance between equity and debt is needed

With investments, there is always a trade-off.

Higher returns bring with them a higher risk of incurring a loss as well.

The higher the return, the higher the risk.

Equity funds invest in the equity shares of companies, which have the potential to generate handsome returns.

Currently, the bull run is on and everyone is making money. But, in a bear market, one can also incur heavy losses.

Investing in debt may provide lesser returns, but the risk of losing all your money is much less. Also, you don't have the volatility that equity tends to have.

Therefore, one must always invest in both.

The equity part of the portfolio provides the kick to generate superior returns. The debt component provides stability when equities slump.

An all-equity portfolio tends to be much more volatile.

What's the balance?

There is no hard-and-fast rule concerning the percentage of equity investment in your portfolio (total investments).

One broad thumb rule states that the debt portion of your total investment should be roughly equal to your age. So, if you are 20 years old, 20% of your investment must be in debt, the rest in equity. 

Eventually, though, it depends on the individual.

1. Safety of capital

If safety of capital (the amount you have invested; this is also known as the principal) is your top priority and you can in no way consider losing your money, you may choose not to invest in equity at all.

On the other hand, if you have no problem taking huge risks, you may prefer the bulk of your investments in equity.

2. Time factor

Equities tend to be a bit less risky on a long-term horizon.

Therefore, a person who is planning to invest for about five years or more, and can digest the ups and downs of the market, may prefer to invest more in equity funds.  

3. Age

Age too is a factor. A younger person has a much longer time horizon to make up for losses in the equity market. An older person, who is closer to retirement, does not have that luxury.

Hence, depending upon the risk appetite, age and investment horizon, one can decide upon a suitable combination of equity and debt funds.

How to invest

Take the total amount that you would like to invest and decide how much of it must go to equity.

Debt

1. List your options

Divide the portion you have selected for investing in debt between investments like the Public Provident Fund, National Savings Certificate, post-office saving schemes, infrastructure bonds and bank fixed deposits.

You could even consider a debt mutual fund. These are mutual funds that invest in debt investments like bonds.

A stock exchange will have a debt market segment and an equity market segment. Just like equity funds trade in shares (in the equity segment), debt funds trade in the debt market segment of the stock exchanges.

2. An alternative to your savings account

If you have some spare cash for a while and do not want to put in the bank, you could try cash funds.

Cash funds are known as ultra short-term bond funds or liquid funds that invest in fixed return instruments of short maturities. Their main aim is to preserve the principal and earn a modest return. So the money you invest will eventually be returned to you with a little something added.

Of course, you will not get the spectacular returns of an equity fund. But you will not face the threat of your investment being reduced to nothing.

To understand cash funds in detail, please read Tired of your savings account?

To locate some good cash funds, please read Great funds to put your spare cash into.

3. Have a fixed time frame?

If you need the money in a particular time frame, say three months or six months, you could consider a Fixed Maturity Plan.

FMPs are mutual fund schemes that last only for a fixed period of time. It could be as little as 15 days or as long as five years.

They invest primarily in fixed return investments like government bonds and money market instruments (very short-term fixed return investments).

To understand FMPs in detail, please read Should you invest in FMPs?

Don't forget to keep some amount of cash in a savings account too, for emergencies or sudden expenses.

Equity

With the amount that you have allocated for equity, you can then decide whether you want to buy some shares directly or only invest in mutual funds.

1. Shares

If you choose to invest in shares, then you must get yourself a demat account and a broker.

Read Buying shares for the first time? to get started.

2. Equity funds

If you choose to invest in an equity funds, you must remember there are various types of equity funds.

For instance, you have sector funds. These are mutual funds that buy the shares of companies of a particular sector. So, if it is an infotech fund, then the fund manager will only buy the shares of infotech companies.

If the sector does well, the returns would be great. If the sector does not do well, the returns could be really bad.

Diversified equity funds invest in the shares of companies of various sectors.

Since diversified equity funds reduce their risk by investing in the shares of companies across different sectors, this makes them less riskier than sector funds.

Then there are mid-cap funds. These are more risky than a diversified equity fund but have the potential to generate better returns too.

To understand mid-caps in detail, read Why mid-caps are hot.

Then there are the contra funds. SBI [Get Quote] Contra and Kotak Contra are examples.

These funds follow a contrarian view to investing. This means the fund manager will deliberately bypass the most popular stocks that everyone is chasing and look for stocks that have strong fundamentals but are trading at a significant discount to their intrinsic value. In layman's terms, this would be a stock whose share price is, say, Rs 15 right now but has the potential to be Rs 100 over a period of time. Yet, it does not feature in the 'favourite list' of other stock pickers.

These funds could take substantial time to offer good returns.

Within diversified equity funds too, funds have different risk profiles. Read How risky is your mutual fund? to understand how to a fund's risk factor.

3. Funds with the tax benefit

You can even consider an Equity Linked Saving Scheme. These are diversified equity funds that also give a tax benefit.

Read Which ELSS fund should you invest in to check out the options.

A mix of both

Apart from diversified equity funds, you can also consider balanced funds. These funds invest around 60% in equities and 40% in debt.

In such funds, the equity part of the portfolio is meant to generate superior returns, the debt component provides stability.

Though the returns tend to be lesser than a diversified equity fund, these funds are suitable for those who are not keen on taking risks or willing invest all their money in equities.

To understand balanced funds better, read Why you must invest in a balanced fund and 5 great balanced funds.

All set?

Do remember, investing is not all about chasing the most favoured investment of the day.

It is more about discipline and strategy.

If you are willing to invest systematically, without paying much attention to the short-term euphoria and slumps, then you are likely to earn good returns in the stock market over a length of time.

But, for your own safety, keep a small portion in debt.

Illustration: Dominic Xavier


 Email this Article      Print this Article

© 2008 Rediff.com India Limited. All Rights Reserved. Disclaimer | Feedback