PS: You need to actively take care of your health to be able to enjoy your post-retirement life, though!
1) Early Retirement Planning – a New Concept:
Ashish’s father, like many Indian parents, does not really understand why Ashish wants to retire early.
He often mentions his own story to Ashish and proudly tells him that at the age of 58 when he was all set to retire from his post as a bank manager in a national bank, he got a 2-year extension. It was one of the happiest days of his life.
This phenomenon of getting a job extension is not new to us.
Most of us have seen our parents slogging and working hard till the workplace forces them to hang their boots. The most predominant idea in our parent’s mind is to work for as long as you can and retire as late as possible.
An idea that automatically is passed on to us, the current generation.
And thus, it is quite obvious that the notion of early retirement is not of Indian origin. Most people believe that it is a ripple effect of the FIRE movement that started in the United States of America.
The full form of FIRE being – Financially Independent Retire Early.
2) What Makes Financial Independence so Important?:
When we speak about early retirement, financial independence is a key element. Not being able to be independent financially would make it almost impossible to retire early.
In simple words, you are financially independent when rather than you working for money, money works for you.
Let us take a look at the 2 major aspects of financial independence.
1) Active and Passive Income
When we talk about financial independence, we need to have an active and passive income. Active income refers to the money that you earn with your hard work, through your work or your job.
Passive income on the other hand, as the name suggests, is passive. You can get passive income without having to work. You can also say that when you are financially independent, you don’t work for money, rather your money works for you.
For example, the money that you have in the bank fetches you an interest. For this interest, you did not have to make any extra effort.
Let me explain with another example, if you rent out a piece of property, the rent that you get is your passive income. And so, it is your money which is working hard to get you more money.
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2) Other Income Sources
In order to consider yourself to be financially independent, you would have to be at a stage where your passive income is much more than your active income.
This stage can be reached when you do not really need your 9 to 5 job and you are not dependent on your salary to manage your expenses.
You earn enough through commissions, brokerage etc. and with these sources of income, your bank balance will always be brimming.
3) How Can I be Financially Independent?:
According to financial experts, there are three major elements that can support you in your goal of being financially independent.
Let us take a look at them:
1) Aggressive Savings
Most of the people who work today generally have a 50-30-20 Income rule, where they spend 50% of their income on their needs.
These are the most basic needs which are crucial to lead life, such as your house rent, food supplies, healthcare etc. 30% of the income is kept for your desires and wants.
These wants are not really a requirement, but because you like them you want them.
For example, you have a number of shirts, but in a shop, you see one that you really like. Now, even when you don’t really need it, buying it is your expense. The remaining 20% is used as a saving, to be used in the future, in the time of an emergency.
However, to plan an early retirement, you can’t really make use of this old 50-30-20 rule, rather you need an extreme way of saving. It is recommended that you save at least 50% to 70% of what you earn.
2) ‘Frugality’ is the Word
When you want to practice extreme savings you simply cannot afford to be a spendthrift, rather, you need to cut down your expenses on just about everything.
Small everyday savings can go a long way, avoiding fancy restaurants, going on a shopping spree, buying expensive gadgets is a Big No.
The crux is that you need to live on the bare minimum. You would have to sacrifice a lot more and keep your everyday desires and lures under check.
Rather than following the formula Savings= Income-Expenditure, follow the magical formula, Expenditure= Income-Savings.
Let me give you another example of being frugal: suppose your need to buy a new phone, so rather than splurging on a phone that costs over 50K, you can also settle for one that costs about 10-12k. Ultimately, you are going to use it for the exact same features.
Spending only on the things that you really need is paramount. So the next time you feel tempted to swipe your cash card, stop and think. And then think a little more.
3) Enough Passive Income
The basic difference between a rich man and a common man is passive income. It is the secret of not just becoming rich but also staying rich. For someone who is not able to create enough to manage his expenses, may not be in a position to retire by 40.
When you start generating enough passive income, it is probably one of the first signs that you are nearing your goal of financial independence.
Your rental income is probably the best way to earn passive income. However, having property to be rented out is itself a costly affair.
In case you do not have a property to rent, you have other options such as dividend income that can be generated through stocks.
Bank deposits are a great way to earn instant passive income
Everyone has the ability to earn passive income, however, the idea has to come from you, depending on the resources you have.
For those of you who have a lot of responsibilities on your shoulders and cannot save 70% of your earnings, FIRE also has the concept of Barista FIRE.
Here, you save as much as you can and build a corpus big enough that allows you to retire from your 9 to 5 job at an early stage.
But, you still continue to work on a freelance basis, work part-time or pursue your dream job/ start-up/ career.
So, basically, you work hard and save harder till your late 20’s and then with the help of this saved corpus or/and if you are lucky along with the help of your parents/ family you will be able to build a platform for yourself from where you can make your start-up take-off.
If your business plan hits the jackpot and turns into a big success you would again be able to retire by the time you reach your late 30’s or max 40.
Do you want to retire before 35? Then check this video out
4) How Much Money Do I Need to Retire Early?:
The concept of “FIRE” is American, and so for people in India, doing the same things as Americans would neither be possible nor useful. You have got to make the necessary alterations to suit your requirements as well as objectives.
So while doing your retirement planning, one of the first things that you need to do is to find out the answer to the question ‘how much should I save for retirement in India’ and for this you need to have a TRA, Target Retirement Amount.
Now to help you calculate this amount, FIRE gives you this simple formula:
Retirement Amount = 25 times your Annual Expenses
Let’s say that your expense in a year is around INR 10 lakhs, so you need to aim at a retirement amount of a minimum of INR 2.5 crores.
So, you need to be able to build a corpus as big as this amount to think about early retirement.
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5) How to Prepare for Retirement before 40?:
Retirement Planning becomes easier when you charter a course at the right time.
Here are top 11 things that you can do, to keep yourself on track. Let us take a look:
1) The Right Career
If you are still in your early 20’s you need to put a lot of thought into what it is that you really want to do. Starting early will help you speed up reaching your goal.
Weigh the pros and cons of whatever it is that you wish to do and move ahead. A family business, your own start-up, setting up a business or even a 9 to 5 job, make a plan and then focus on the execution.
2) Estimate Your Post Retirement Expenses
This is probably the first rung of the ladder. When you want to retire early and are thinking about how to prepare for retirement, the first thing that you need to do is calculate the “how much” would you need on a monthly basis.
An ideal situation would be that you enter your retirement period debt-free, however, you would have to cater to rent, grocery, clothing, transport, travel, utilities, insurance premiums and healthcare.
3) An Emergency Fund
Be it before or after your retirement, having an emergency fund is crucial. Life is unpredictable and ups and downs are its part and parcel.
Your budget may alter in different phases of retirement, at the same time you need to keep a separate fund in case of a medical emergency or a financial family commitment.
4) Strategically Budgeting
Making a budget is easy, sticking to it requires strict discipline. You would have to earn more and spend less. We have already spoken about frugality and its importance.
You would have to clearly differentiate between your needs and your wants and then make a saving strategy.
5) Bank The Extra Cash
Though most of us rely on plastic money and prefer making cashless transactions, still putting the extra cash that you get in the form of gifts should be put in the bank straight away.
These small additions to your savings account fetch you interest and thus, can go a long way too.
6) Find More Ways To Save
Apart from living on 30-40% of your income, it would be a great advantage if you can explore more ways of earning an extra buck. Depending on your job profile, see if you can work overtime or find a part-time job.
Take tuitions, work on commission, make investments, just about anything that works for you.
7) Seek Professional Help
Another important aspect is choosing relevant saving vehicles that would allow you to save more in a shorter period of time. For this, you can always seek the help of a financial advisor.
A professional would be able to help you in designing a road map and also developing an investment strategy that works for you. The plan would help you reach your goal in a more systematic way.
Reach out to our certified financial planners to help you design your financial journey
You also need to estimate the growth of your savings. Making short-term goals would help you in getting a fair and honest picture of whether the ‘Goal of Retiring early’ that you have made for yourself is within your reach or not.
Set a monthly saving goal, and gradually go to half-yearly and yearly goals. If you are able to reach your set limit, you can consider that you are on the right track.
11) A Back-Up Plan
Stay positive and work towards your goal, but at the same time be realistic and always have Plan-B.
By putting all your emotional eggs in one basket, you may be heartbroken if ‘early retirement’ doesn’t happen for you.
6) Early Retirement – Do You Really Want It?:
The idea of early retirement can be very appealing, but, most of the time youngsters are drastically underprepared for the same. Though, there are many who are prepping up to shed their 9to5 gig as early as possible.
And though this can be seen predominating the US, to do so in India, you need to really think it through.
If you are someone who is already in your dream job/ or are doing something that you are passionate about, early retirement might not be the right option for you.
For example, if you are a school teacher who loves teaching and interacting with young ones, you may not really want to retire. Forget about retiring at 40, you may want to keep teaching beyond 60 too!
However, if you are someone who has Monday Blues on a weekly basis and often finds yourself stuck in a career that you resent, then you may want to call it quits.
But even if you begrudge your job, does that leave retirement as the only option.
Explore the options of changing your vocation even if it means having to start from scratch or taking a sabbatical or acquiring a new skill-set.
Having a broader outlook might offer you a better and wiser choice.
The Bottom Line
Retiring early may seem a distant dream, but it sure is possible. However, you cannot do it without having a very clear road map in front of you.
And thus, it requires a lot of planning and aggressive saving. Remember, it is never too soon to begin mapping and saving for your retirement. The day you get your first paycheque is probably the best day.
You would have to be proactive and very disciplined in your approach. In a time when you can shop online sitting in your cosy bed, not being lured by Big Sales and Deals might be a little too difficult.
If you are really good at stalled gratification and can seize every opportunity to save more and more.
There must be a lot of people who would want to retire early. After all who wouldn’t want to sit back and relax. However, keep in mind that if you aim to retire early, it would require a lot of preparation.
Every small expense, saving would have an effect on how early you can reach your goal.
But, with the right plan and hard work you would surely be able to say sayonara to your workplace and retire at 40, and then as they say “After climbing the mountain, you can finally enjoy the view”.
We have designed a special course on financial planning and how to grow your money at a very early stage. Enroll now!
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Every ‘first’ is special. However, when it is the ‘first job and ‘first’ salary, the feeling is unparallel. It not only gives you financial freedom but also sets you free and can work as a confidence booster.
However, we often get way too excited with our first salary and spend it on things which give momentary pleasure. It is not wrong to fulfil those dreams which you had and wanted to fulfil with your own money, but you also need to consider certain other things which can give you long-term benefit.
In this article, we will discuss Investment for beginners. We will tell you how to start your investment journey with multiple avenues that are available. We will also help you chalk out the plan for starting your investment journey.
One of the crucial things that will be discussing is why you should invest early and how it helps you accumulate more wealth.
First Job? Here’s how to invest your first salary:
Before we dig into the different ways or steps of investing your first salary and the subsequent ones as well, you should be aware of certain financial concepts which will affect your money. There are three basic financial concepts which are –
You need to understand how each of these factors affects your investments both in the short and long term.
Compounding of Money
You must have come across elderly people and even some of your friends and colleagues who suggest you start investing early. Have you ever wondered why you should invest early and what benefits you can have by doing the same?
This takes us to the concept of compounding.
What is compounding?
If we talk about compounding, then it can be defined as the process of earning interest over interest. This means, the amount you invested in any investment instrument, that earns interest, and you reinvest that interest and then earn interest on both the principal amount invested in the beginning and also the interest that you reinvested.
This is going to give you more return than investments within simple interests.
Most of the investment vehicles provide the benefit of compounding. The interest so generated over the principal amount and accumulated interests over a period of time is known as the compound interest.
The compound interest is calculated by
= [Principal (1+ interest rate) number of periods] – Principal
= [P(1+i)n] – P
= P[(1+i)n – 1]
For instance, you have invested your Rs. 10000 for 5 years at an interest rate of 5% compounded quarterly.
Then; CI = 10000 [(1+0.05)20 -1]
= Rs. 16532 (rounded off).
How does it work?
The frequency of compounding plays the primary role in accumulating your money over time.
The compounding frequency is directly proportional to the growth of interest. If the frequency of compounding is more, then the interest would grow fast and you can accumulate more wealth.
Let’s see an example –
Suppose, you invested Rs. 15000 at an interest rate of 5% p.a. for a period of 5 years. Now, let us look at the table below which will show how your wealth will grow with different compounding frequency –
No. of Compounding Periods
Values for Interest (i) and Number of periods (n)
Total Interest Amount (INR)
i =5%, n = 5
i = 2.5%, n = 10
i= 1.25%, n = 20
i= 0.4167%, n = 60
So, from the above, table you can understand how interest amount changes along with the change in the frequency of compounding.
When the frequency increases, the interest amount grows faster.
Relation between early investments and compounding
The relation between investing early and compounding is based on the above concept. If you invest early, then your money can be compounded more times. This will eventually help you accumulate more wealth.
Who doesn’t want to earn money on his or her own money, isn’t it? Compounding gives the platform to do so. You earn interest on your previous interest.
So, the early you start investing, you can reap higher profits. So, with your first salary, try to invest in some investment vehicle that provides compound interest on the investment.
Watch our video on Power of Compounding
The second basic concept of finance and investment is inflation. It is the rise in the general price level over a period of time.
While compounding interest help your money to grow faster, inflation does the opposite. It tries not to grow your money or the value of money.
So, inflation and the growth of your investment have an inverse relationship. When inflation is on the rise, the growth of your investment falls and vice versa.
Suppose, you invested in an instrument that provides a 5% return. However, the inflation rate is also 5% in the country. So, the actual growth in your investment is nil. It is because the money you accumulate from your savings will have the same value as it had when you invested it.
To combat inflation, you need to understand “why you should invest early”.
Finally, we have ‘risk’ which is one of the primary factors on which your choice of investment depends. When you are just starting your investment journey, you can take more risk, and eventually when you grow and the level of risk should start decreasing.
The reason behind this is, at an early age, you have multiple opportunities, time by your side to make up for any losses. However, with passing time, the opportunities decreases, and your risk appetite as well.
So, all these three components play a vital role in determining your investments and the growth of it.
So, keeping all these three in mind you need to find out how to start your investment journey and here we can help you to plan the same.
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2) Prepare a financial plan:
The first step to invest is to plan. Planning your investments and finances is crucial before you take any step.
There are multiple steps involved in making a financial plan so that you can invest properly. In fact, this is the ideal way to start your journey of investment for beginners. Let us take a look at all of them.
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Create a contingency fund
With your first salary, not just buy gifts for your parents, create a contingency fund as well. A contingency fund will help you survive in a time of crisis or emergency.
Since, life is uncertain and money is required for almost everything in this world, keep an emergency fund is inevitable. So, with the first salary, you must promise yourself and keep aside a part of your salary that you will not use without any major crisis.
This will not only help you in an emergency but will also develop your savings habit.
Set your financial goal
Step 2 for investment planning is to pen down your financial goals. Financial Goals are nothing but determining the amount you would need to fulfill your financial aspirations like buying a house, wedding, higher education, and others.
Take a pen and paper and write down all your short-term, long-term, and even ultra-short and ultra-long term goals.
This will give you clarity of what kind of investment you would need for fulfilling these dreams in the future.
This is a very important aspect of financial planning to understand “how to invest properly”.
Make a savings Budget
The next step is very vital for savings and that saving is going to get invested.
Assess your income:
Firstly, you need to assess all your earnings.
The primary source of income for you is your salary from the job you just joined, apart from that if you have any other source of income like rent, interest income, or others, you need to evaluate and calculate them all.
List down expenses:
After income, assess all the expenses that you cannot do without. Check where you are spending the most. Try to chalk out plans to cut down certain expenses.
This can be done by making a proper budget for a period – say a week or month. You can list all the essentials and necessary things where you need to spend.
Then stick to the budget and at the end, evaluate whether you spent more than your budget or not and accordingly plan the next.
Save at least a minimum part of your income:
Once you start budgeting, your expenses can be curtailed. This will give you a provision for saving at least a part of your income every month.
Many eminent finance experts say that you must save 50% of your income and consume the rest.
However, in real life, that seems a little impractical given the average salary and the growing inflation but you must save at least 10% to 25% of your income and make it a habit.
The next step is to assess your assets and liabilities. Assets are your possessions that generate an income while liabilities are the debts that you need to pay off.
If you have availed of loans, assess them and manage them efficiently. Loans like personal loans and credit card debts are high-interest debts that also impact your credit score severely in case of repayment default.
So, pay off these high-cost loans. Good loans like home loans, car loans, etc. can be continued since they build your credit history and home loans also save taxes.
Know the value of your assets so that you can estimate the additional funds needed for meeting your financial goals.
4) Assess your risk-taking ability:
Your savings should be invested in lucrative avenues for wealth maximization. However, the choice of the avenues depends on your risk profile.
Assess your risk appetite, i.e. your risk-taking ability. Find out if you are comfortable with market-related risks or you prefer playing it safe. If you are a risk-taker, you can invest a primary part of your savings in equity to get attractive returns.
On the other hand, if you are risk-averse, you should minimize your equity exposure and invest in debt instruments that give stable returns.
So, assess your risk appetite before making investment decisions so that you can pick the right investment tools if you wish to understand “how to start your investment journey”.
Here is our full article on How Young Professionals can do their Financial Planning. Read Here
5) Invest in health insurance::
Even though you are young and might be healthy, the need for a health insurance policy cannot be ignored. Accidental injuries or illnesses might strike anytime and they incur considerable medical costs.
So, after you become financially responsible, ensure that you invest in a suitable health insurance policy for coverage against medical contingencies.
You can buy an individual health insurance policy covering yourself only or you can opt for a family floater plan and cover yourself and your parents under the same policy for wider coverage.
Opt for an optimal sum insured, i.e. Rs.5 lakhs or above, for sufficient coverage against expensive medical costs.
6) Invest as per your risk appetite
If your query is “how to invest my salary in India?”, you need to estimate your risk appetite and then invest accordingly. Now that you have taken care of the preliminary steps, it is time to invest your savings into suitable avenues.
When it comes to investment avenues, there are various alternatives. However, you should keep your risk appetite in mind when investing.
If you have a high-risk tolerance and want to invest in equity, you can choose stocks, equity mutual funds, futures or options.
On the other hand, if you have low tolerance, opt for fixed deposits, PPF investments, etc. that have a fixed rate of return. Try and start a Systematic Investment Plan (SIP) in a mutual fund scheme, equity or debt.
SIPs would ensure regular investments without pinching your pockets and provide attractive returns which would compound over time to create a sufficient corpus for your financial goals.
7) Review, monitor and track your investments regularly::
Investing is not a one-time task. You should invest in a disciplined manner, regularly, so that you can create a considerable corpus over time through the miracle of compounding.
Also, monitor your investments regularly. This would serve two purposes –
You can check if your investments are performing as expected
You can assess their sufficiency in fulfilling your financial goals
If your investments are not performing as expected, you can switch around or churn your portfolio to get the right asset allocation.
On the other hand, if your investments are falling short of creating a desirable corpus, you should step them up to accumulate the desired funds.
Make it a habit to track your investments once every 6 months or so so that you can take necessary measures to correct any deviations.
Managing personal finances and other finances can be a bit difficult task. Check our course from Koppr on Relationships and Finance
8) Plan your taxes::
The last step is to plan your taxes. Tax planning helps you utilize the tax-saving sections of the Income Tax Act, 1961 so that you can reduce your tax liability.
Tax planning allows you to pick the right investment avenues that not only match your risk tolerance but also give you the added benefit of tax saving.
When you plan your taxes, you can reduce your tax outgo and increase your disposable income.
An increased disposable income can, then, be used to upgrade your lifestyle as well as your investments so that you can save more.
These are some of the basic principles of investment for beginners. They are also the stepping stones to financial independence and should not be ignored.
So, if you are wondering, ‘how to invest my salary in India’, wonder no more. Follow these tips and plan your finances effectively.
These principles would give you financial literacy and also equip you with the knowledge of how to start your investment journey. While the latest mobile phone might be tempting you to splurge your first salary in one go, resist the temptation. Make the phone your goal, save for it for a few months and then get your hands on it.
The pleasure of planning your finances for the phone would motivate you to plan for your financial goals too.
So, don’t be frivolous with your first salary. Know how to invest properly and make your first salary the first instalment towards your financial independence.
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Wisdom often comes through proper coaching and this is precisely why you need to impart financial wisdom to your kids at the earliest. Children who learn about money early on in life are more confident about it later in life.
They handle all the money matters with greater ease and become financially independent and confident adults. Money management is a skill that needs to be learnt through training and observation.
As a result, you need to be the best coaches as well as role models for your kids to look up to.
Take a look at this article to know why financial literacy for kids is important and how to go about it.
It is important to have some financial lessons for kids. But simply making the child sit and listen to lectures about money management won’t help your case too much.
Children learn through practical experiments. This is why you must try to include financial literacy in their day-to-day schedules. From making them earn their allowance money to making them responsible for every penny they spend, financial knowledge is imparted through practice.
Tips to teach financial responsibility to your kids
Take a look at these 10 handy tips on how to teach financial responsibility to your children:
1) Introduce the concept of earning money:
It is a common practice for kids to receive money from their parents. You give your children allowance money, or you give them money on special occasions.
Try introducing the concept of earning money with your children. I suppose you pay your kids INR 2000 as their monthly allowance, break it up into small sums and ask them to earn the money.
If you have a small child, start with something like putting away the shoes in the shoe cabinet every time he comes back home. For this, he earns INR 500 a month.
For an older child, set up a chore like taking the garbage out each morning. For even older kids, set tasks such as washing the car every Sunday or walking the dog in the evening. Set fixed amounts of money as ‘salary’ for each chore and make your kids earn their allowance.
Reason: Doing so will make the children more responsible. They will also take daily chores more importantly. Then, the greatest benefit will be that they will start valuing money.
When they have to earn the money, they will understand its importance in a deeper and more detailed manner. They will stop assuming that money is just an object that comes from their parents’ wallets.
One of the best financial literacy activities for kids is to give them a commission. This can be done in a simple manner. If you are sending your kids to buy vegetables, tell them that they will get 10% of the money that comes back.
So if they take INR 200 with them and spend only INR 100, they get to keep INR 10 for themselves. This is an important financial concept and also a wonderful way to make your kids understand the value of money.
When they have this incentive, they will look for better bargains and offers. Else, they’ll be lackadaisical and just buy vegetables from the first shop they see. If they know they can earn some money out of the process, they will try to bargain, look around and also understand deals and discounts in a better way.
Reason: This is an activity that not only teaches your kids about money, it also makes them more responsible in general.
Kids, especially tweens and teenagers, are often laid back and least interested in household matters.
They may even end up thinking that money is free as they see their parents buying and arranging for all their needs, without them having to do anything.
Prevent your child from getting into this mindset by introducing the concept of commission and see a visible difference in them.
3) Make a jar for savings:
Rather than just handing over a currency note to your child when he’s going out or at the end of the month, encourage him to have a savings jar.
Each time he completes a task and earns an income or commission, ask him to put the money in the jar. Also, if he has any money left over after using it to buy his toys, etc, he can put the change back in the jar.
Reason: This will broadly introduce him to the banking system. You can then explain to him how money is saved and how it is taken out for expenses. This is a very simple, but highly effective way to teach financial literacy to young kids.
4) Give them three piggy banks:
When teaching kids finance, try giving them three piggy banks instead of just one. A piggy bank is a common household item that almost every kid has.
Kids enjoy putting their money in such piggy banks and taking them out when needed. Put three distinct labels on the three banks – SAVE, SPEND and GIVE.
Whenever your kids get a sum of money, whether it is the money you pay them for completing their designated tasks, as a commission or simply as a gift, they need to segregate the amount and divide them between the three banks.
The first bank, labeled ‘SAVE’ can be used to keep the money they want to save for large expenses such as buying a video game or going on a trip with their friends.
Each time they receive a sum of money, they need to keep aside a part of it to make the ‘SAVE’ fund grow. The next bank can be labeled as ‘SPEND’. Your child will want to make small expenses such as buying an ice-cream or a storybook.
For that, he can dip into ‘SPEND’ bank and take out the amount of money needed.
And finally, the third bank can be labeled as ‘GIVE’. The money in this bank can be used to buy presents for a friend’s birthday, to buy a Mother’s Day card, etc.
The concept of three piggy banks is an excellent way in which you can teach budgeting to your kids.
The kids will learn about dividing the money they have and also being judicious about spending.
They will get to know the value of money too and this will add a lot of value to your overall financial lesson plans.
These days, a lot of the financial literacy curriculum for elementary schools include lessons that talk about the importance of cash as gifts. Holiday gifting, birthday gifting, etc can be easily replaced by cash.
There are several benefits of doing so. First and foremost, as parents, you are saved from the troubles of thinking about what to get the kids, spending time and effort shopping for the gifts and finally having to deal with the disappointment of your kids not liking the gifts!
Rather than giving gifts, switch to cash of the same value. If you decided to give your 8-year-old daughter a new bicycle worth INR 6000 for her birthday, give her the cash instead.
She can then divide the money among the three piggy banks, and consolidate her concept of budgeting. Next, handling money will definitely sharpen her math and calculation skills and finally, it will make her shrewd and responsible about the cash she has in hand.
As you can see, there are several benefits of giving cash as gifts to your kids. Also, encourage your friends and relatives to give your kids money instead of unnecessary gits during birthdays and other occasions.
6) Open a bank account
Once your child has understood the concept of saving and budgeting, proceed to open a bank account for them.
If you are looking for a true answer to how to explain money to a child, your best bet would be to open a bank account for them.
There are many, many benefits you get when opening a bank account for a child. Some of them are:
Understanding the rules –
Involve your child in the process of opening the bank account. While doing so, explain the steps such as filling in the application form, reading the clauses, arranging the documents, signing forms, etc.Your child will find it exciting as will learn immensely from it as well.
Handling bank documents – After the account is opened, your child will receive the banking kit which will include the important banking documents such as the cheque book, ATM card, etc.You will have full authorisation over these documents, but tell your child about the way in which they work. Every time you go to the ATM, encourage your kid to insert the card, enter the PIN and count the money, while you supervise the entire process.This will make the child very organised and also very knowledgeable about the entire banking process.
Being responsible –
The biggest advantage of doing this perhaps will be that your child will become financially responsible.He or she will also feel important and take pride in the fact that he or she has a bank account.This will build the base for a strong understanding of the banking system in the future.
These are all important financial lessons that your child can learn after having a bank account of his or her own.
Using your phone to scan a QR code to make daily payments has become very commonplace these days.
From the grocery store to the medical store, from restaurants to hospitals, everywhere online payment modes are now preferred over the traditional cash payments.
Your kids always observe what you do and you should grab this opportunity to teach them about electronic transactions.
E-money is a very pertinent topic in today’s day and age and every child should be aware of it. Coach your kids on how to properly use this payment mode. Also, tell about the possible frauds that can take place in the medium.
The same applies to online card payments and net-banking. If you’re sitting at home and paying your utility bills online, make your child sit next to you and teach them how it is done.
While doing so, you can also talk to them about how bills are generated. Explain to them hope savings and proper usage of the various materials can lead to cost-cutting.
Reason: Regular participation in such important financial matters will definitely make your child money-wise from a very young age.
8) Discuss family finances in their presence:
You need to discuss the family financial matters in front of your kids. Sadly, in many families, money is a taboo topic and hence it is never discussed in the presence of young kids.
This is unfortunate because the children also grow up with the understanding that money is evil and they never discuss it openly with their parents.
Parents are the first teachers of a child and so you should impart proper financial knowledge to your kids. Tell them that money isn’t evil. Inform them about the importance of money and about the need to be responsible for it.
Reason: Make money as a dinner-table conversation topic. Discuss the expenses, bills, etc with your spouse in a very matter-of-fact manner. This will make your kids realise that money is a part of life.
They will also learn that money matters can be discussed openly. By doing so, you pave the way for them to be confident about discussing all the challenges they face while handling finances later on in life.
Many young adults mess up their financial health, but with proper guidance can recover from these mistakes. Ensure your child always has the confidence to come to you when he or she is in a financially sticky situation.
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9) Make them aware of the debt:
A very important component of money is debt. Debt is a necessity, but it can turn into a huge liability. Your kids need to be told about this as early on in life as possible. Doing so will prevent them from misusing debt as a medium to escape their financial duties.
Children will eventually learn about debt, but if you teach them, they will learn it in the way you want them to. If you are happy with the way you are managing your own debt, just tell them about the model you follow.
If you yourself are not happy about the mistakes you made in regards to debt, tell them what to avoid.
A few good guidelines in this respect are:
Encourage them to budget. The less they spend, the less they have to pay.
Tell them to stay away from things that are not affordable. Encourage them to save enough before they get the item, instead of using credit to buy it.
You need to be a role model, so if you have debt, pay it off diligently. Share the EMI details with your kids and show them how you are paying the EMI each month and what you are achieving out of it.
If your child is slightly older, explain the concepts of credit and the interest rates associated with it.
Make a clear demarcation between the things that are NEEDED and the things that are WANTED. Need and want are two sides of the same coin, but play a huge role in maintaining a person’s debt and credit balance.
Reason: Make your children understand the concept of debt very clearly at an early age so that they are conscious about it and avoid piling on debt upon themselves as they grow older.
This is one of the most valuable financial lessons for kids.
10) Teach them to appreciate the money they have:
Many kids indulge in comparison. They will compare their clothes to the clothes their friends wear, or they will complain that their cousins have a better car than they do. You must discourage this habit and tell them to appreciate what they have.
Children are often used to receiving everything on a platter. Make your kids understand that money isn’t free and it isn’t just an object that is readily available in their mom or dad’s purse. They should learn to value what they have.
To do this, introduce the concept of saving. If they want something, ask them to earn it. Once that is done, they will understand how difficult it is to earn money and buy something.
Reason: Kids who value what they have and value money in general, grow up to be financially smart adults who are responsible for their savings and spendings. They are also content and happy in life because they know what they have is what they rightfully earned.
To put it in a nutshell
Children are very smart and they learn very well.
They are like sponges who soak up what they see and hear around them. Impart the best financial knowledge to them and make them financially aware and independent adults.
Finance for kids is not a difficult topic to navigate around – just keep all the points mentioned above in mind and you will be able to do it without any hassles whatsoever.
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Irrespective of the current financial state of a person, everyone wants to die a rich person. However, in the 20 years that I spent in the financial services industry, I have noticed that most people either lack the awareness of proper financial planning (though they may not acknowledge it) and to add to it, hiring or consulting a certified financial planner freaks them out.
If you too feel the same way, let me tell you that you have many on your side even today.
However, if you are looking for mental, emotional wellbeing for yourself, then paying attention to your financial wellbeing is an important key to achieve the former two. Financial wellbeing refers to how ably you have planned for the future and not just your current financial status.
If not paid proper attention to, your financial security/ stability is likely to affect you as badly as your combined stability in your profession, relationships and concerns around your physical health.
However someone specialised in comprehensive financial planning helping you sort and plan your finances can be life-changing for you – you are likely to have a 5 kg brick off your head, thus freeing up your capacity to concentrate on your professional and personal matters efficiently and effectively.
It is quite natural that you may feel that you do not need a financial planner/advisor to help you plan your finances/ investments. But beware before you arrive at that conclusion.
If the answer to any of the following questions is a ‘no’, then you might think twice before you dispel the idea of hiring a certified financial planner-
Do I have enough knowledge of finances and investments?
Is wealth management your forte? Do you have a knack of learning or reading about financial planning, wealth management or any other financial subjects or like researching them?
Are you an expert in managing and monitoring various financial instruments?
Do you really have the time to evaluate your portfolio from time to time and make periodic adjustments in them to reap your best returns?
Who is a Certified Financial Planner?
A certified financial planner India is an individual who helps people manage their finances. These individuals are given this formal designation of ‘Certified Financial Planner’ or CFP by the ‘Certified Financial Planner Board of Standards, Inc.’
This is because they are trained and thus equipped to guide people plan for various financial goals in their lives viz. Education, weddings, retirement, buying assets like houses/ apartments, protection with various insurance coverage and tax planning as well.
To become a qualified Certified Financial Planner (CFP) is a difficult task. One has to undergo stringent processes and conditions pertaining to passing of standardised examinations, experience, ethical standards and formal education.
Most importantly, all CFPs are ethically and legally bound to take all decisions and act solely in the best interest of their clients. This is referred to as being on ‘fiduciary duty.’
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Certified Financial Planners offer comprehensive financial services against certain considerations –
One Time fee – If you are consulting a CFP for a specific need, like resolving a specific issue or making a financial plan for you, the Certified Financial Planner is likely to charge a one-time fee from you. You then take your investments ahead on your own basis the roadmap defined by the CFP for you.
Hourly fee/ flat rate – Many investors consult CFPs against a flat fee, on a regular basis in order to review their portfolios or plan new investments from time to time.
Commission fee –
Common in India is a commission fee, i.e. a percentage of amounts of money being invested in any vehicle are shelled out as a fee to the CFPs by the respective companies/ vehicles where the money is invested.
Why do you need Certified Financial Planner?
You may be a fresh graduate seeking to pay off your education loans post landing with your first job, or someone about to retire and is looking for avenues to ensure a seamless flow of monthly income, or maybe at a life stage somewhere in between, we all look want the money we are making or have made in life to work towards meeting our financial needs.
These life events and more prompt us to reach out for qualified and custom made financial advice. This is because there is always a chance of making a bad financial decision leading to major losses of hard-earned money.
Detailed below are various life scenarios when you might want to go for professional financial advice by either individual CFPs or financial planning firms.
I am on my first job and have my education loan to be repaid yet want to start saving for the future.
I need proper tax planning to ensure I pay a minimum tax on my salary from service/income from the business.
My parents are retiring and I being the sole earning member need to ensure family expenses in the face of an unforeseen event in future.
I plan to buy a house/ apartment in a few years from now post I get and settle down in life. I need help to plan for my future down payment.
I recently got married and now need help to plan our finances together as a couple.
We just got a child and need to plan for its future education, marriage and other financial needs.
My spouse and I do not agree on financial decisions and need comprehensive financial planning by an expert who can act as a mediator and give the right advice.
I am a single person and have no inheritance; thus need to plan investments towards wealth creation for myself to achieve my dreams in life.
I have inherited some wealth from my parents and need guidance to fruitfully invest the funds to yield maximum returns in future.
I do not have knowledge of the right financial instruments to invest my money and need expert advice to help me manage my finances.
I have been managing my finances till now, but need a second opinion to understand if I am on the right track to achieve my financial dreams.
I do not enjoy saving or investing money but/ and need professional advice to ensure I do not mess up my future financial health in the face of uncertainties.
I recently got widowed/divorced and need guidance to reorganise my finances for my future to move on as a single person.
I am about to retire and need professional support to ensure a regular flow of income henceforward from all the money I have earned so far to take care of my expenses and live my post-retirement golden years as I have dreamt of my me and my spouse.
My parents are growing older. We need professional help to check if all the financial planning done till date will suffice their financial needs going forward.
Advantages of Consulting a Certified Financial Planner
Famed English fashion photographer David Bailey had once said, “To get rich, you have to be making money while you’re asleep. “ If your aim is to get rich, then seeking professional advice from a certified financial planner can prove to be advantageous to you.
However, comprehensive financial planning is aimed at and comprises strategies to increase returns on the portfolios by keeping a close watch on the various investments vehicles; with the investment objectives of the client in mind.
Trying to get this done by one’s own self poses a complex task as too many investment options available in the market; mostly leaves investors confused. Further one needs to be mindful of the various instalments and/ or maturity dates to ensure continuity of the schemes to benefit from them.
Also, timely churning of maturity amounts into profitable reinvestment options (keeping taxability in mind); need exploring of advanced investment strategies. All these may prove to be overwhelming to an investor who is required to devote his/ her time and attention elsewhere to take care of various priorities.
Top #5 reasons to hire a Certified Financial Planner:
Hiring a certified financial planner is likely to prove a prudent decision if one wants to save time and reduce hassle – thus reduce stress at the same time.
One of the most common reasons a CFP is hired is with the expectation to maximise the net returns on the portfolio investments. Though no one can guarantee the above, there are several advantages of hiring a Certified Financial Planner to manage your investment portfolios.
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Let us take a look at the advantages of employing a CFP.
1) Helps to reduce stress by saving time and energy:
The most important reasons behind making investments revolve around the facts that –
We want to achieve all the financial dreams and meet exigencies along our life’s journey, and
Post-retirement we should be able to reap returns from our hard-earned money to ensure a stable flow of income during our golden years
However, managing and monitoring investments on our own may actually pose a hurdle to the above objectives.
This is because our jobs and businesses demand full attention to make money and progress in our chosen careers.
Making and dedicating enough time to research and plan our investments to make our money work while we are sleeping or away in earning money, requires persistence, and dedicating so much time on a regular basis is definitely a challenge.
On the other hand an expert in this field – a CFP will happily and proactively take the desired responsibility while you are away.
2) Dedicated specialist to make money work for you:
Certified financial planner and financial planning firms are specialists and trained portfolio managers who dedicate their lives to plan and manage investment portfolios as their vocational expertise.
Thus their service with their functional knowledge, expertise and continued investment strategies can truly prove to be helpful to individual and organisational investors as well.
3) A timely and thorough review of investments:
Employing a qualified CFP to manage and control investments means giving complete control on one’s investments to an outsider. This can be a cause of doubt or suspicion for many as money has an emotional attachment to its owner.
This apprehension can always be taken care of by consulting and taking a second opinion from another CFP.
4) A stepping stone to learning investment planning:
If you are not a trained investment advisor by profession; appointing and observing a Certified Financial Planning Manager work out personalised investment strategies for you and others is a great learning experience in itself.
Most CFPs have their unique consulting and approach to investments for every client based on the latter’s needs. Thus watching the applied investment strategies and tools used to meet various financial objectives, will lay the foundation to your own interest in investments and acquiring further knowledge in the field to subsequently help you manage and monitor your own portfolio as a financial planner too.
5) Trained and expert capabilities:
Generally an externally hired qualified CFP approaches investment planning for their clients with their personal experience and expertise coupled with a foolproof financial planning tool which may otherwise not be available to you as an investor.
Neither will an investor be in a position to think about it on their own. The comprehensive financial planning done for you by a certified financial planner using his/ her business acumen is likely to widen your horizon of market information around unknown territories of investment categories, tools and opportunities to strengthen your portfolio thus improving its efficacy in supporting you in achieving your life goals.
All of the above is likely to make you aware, more interested and raise your accountability towards being mindful and be focused on achieving your investment goals to help you live your financial dreams in life.
We at Koppr aim to enable you to be financially fit and lead a financially healthy life. If you take charge of your financial plan with the help of experts along with the necessary tools to assist you, you can take control of your financial plan.
As said, financial freedom is just not for the riches, it’s for every one of you. You can simply start your investing journey with Koppr.
Investment = wealth creation or at least what you want to believe. However, whether it is due to mistakes, ignorance or a lack of financial literacy, your investments might not give you the desired results and might also result in a loss.What can you do to avoid losing money through your investments?
Investing is an art and unless you learn to master the art properly, your investments might leak money rather than accumulating it into a corpus that you need.
So, here are 9 tips on how not to lose money by investing right –
What is the basis of your investment? Creation of funds for your financial goals, isn’t it? So, start at your goals first. It is useless planning a journey anyways without having a destination in mind.
So, jot down your financial goals, both short-term and long-term. This listing would give you two distinct benefits – it would help you find out the corpus needed for each goal as well as the time horizon.
These two inputs form the basis of your financial plan and so, knowing your goals is the groundwork that you need to do before you jump on the investment bandwagon.
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2) Risk Profiling
The next thing to find out is your risk appetite. Risk appetite means your capacity of taking risks. Depending on your risk appetite the investment avenues would be selected.
If you don’t mind taking risks, you can invest in equity-oriented avenues and if you are risk-averse, fixed income avenues would be better.
Risk profiling should assess your tendency to bear risk vis-à-vis your age. Nobody like losing money and so, risky avenues are always seen with a bit of hesitation.
However, if given time, risks tend to smoothen out and you can get very good returns from risky investment avenues, i.e. equity. So, even if you are risk-averse, you can invest in equity provided – age is on your side and you have a long term investment horizon.
When you are young, you can give your investments time, time which minimizes the inherent risk. So, equity is suitable for long term goals. Do not lose your money by investing in the promise of equity for a quick buck.
Equity is highly volatile and while it can give quick gains, it can result in capital erosion too.
3) Tax Planning
Many of you also lose out on your returns because you don’t plan your taxes properly. Remember every investment avenue has its own tax implication.
If you understand such implication and then plan your investments around them, you would be able to save tax and generate good post-tax returns.
So, tax planning is essential, both when investing as well as on redemption. Find out which avenues help you save tax on investment so that you can reduce your taxable income while saving (Section 80C should be understood properly).
Then, when you redeem, check how your gains would be taxed and if you could do anything to avoid or reduce the possible taxation. A very common example is redeeming equity mutual funds.
If you redeem your investments within a year, a short term capital gains tax of 15% would apply on the returns that you have earned. On the other hand, if you redeem them after a year, you would be able to save tax if your returns are within Rs.1 lakh.
Even if your returns are greater than Rs.1 lakh, only the excess return would be taxed, and that too at 10%. So, if you are redeeming your mutual fund investments, check for the tax implication to see if you can save tax.
Losing money is not only through negative returns but also by not planning your taxes efficiently and letting them eat into your returns.
4) Know When to Hold and When to Redeem
This is a very technical aspect, especially when investing in equity stocks or equity mutual funds. Balancing between holding and redeeming is a fine line, one that you should toe with careful consideration.
If you hold your investments and the market falls further, you would lose money. On the other hand, if you redeem or switch and then the market rises, you would lose again as you could have earned better profits.
So, this is a tightrope and many investors fall flat while trying to walk it.
Wondering what you should do? Well, the answer lies in the first two points discussed earlier – goals and risk appetite.
If the market is falling and your goals are long term in nature, you can hold onto your investments as the market would correct itself, no matter its bearish run. In fact, the Sensex has emerged stronger after every crash. Have a look –
If you are on the initial curve of the fall, you can also book your profits and switch to debt mutual funds to protect against the volatility.
If you have a low-risk appetite, then also you should book your returns and switch to debt to prevent losing money.
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5) Invest When the Market is Down
When the market is in a bear run and falling, it is a good time to invest as the stocks would be undervalued. Thereafter, when the market would rise, your investments would give you attractive returns.
So, a falling market is not necessarily a sign of losses. If you look on the brighter side, you can actually make profits by investing in undervalued stocks at that time.
That being said, try and buy good companies at a cheaper value and not bad stocks. Good companies would give good returns but bad ones would never do, even when the market is bullish.
So, try and choose the best-rated stocks with a high Price/Earnings (P/E) ratio as these companies would deliver good profits.
Which is your favourite investment avenue? If only one or two names spring to your mind, it is a cause of concern. Can you live on one food for your entire life? Variety is the needed spice, isn’t it, both from the taste and nutrition point of view?
So why play favourites with investments?
Your portfolio should be a mix of different investment avenues with different asset classes.
You need a mix of –
– Equity and debt investments
– Long term and short term products
– Fixed and liquid avenues
So while mutual funds are good, a little bit of fixed deposit should also be a part of your portfolio. Similarly, if gold is your preferred avenue, invest in equity too for liquidity and better returns.
A skewed portfolio, with a majority of one or two investment avenues, is a recipe for disaster. If any one of the avenues does not perform well, your entire investments would be in jeopardy.
For example, if you have a heavy proportion of real estate investments, where would you get money for emergency needs?
Too much exposure to equity is fatal in a market crash and too much investment in fixed income avenues is suicidal from an inflation point of view.
What you need is a balance of flavours, a balance of nutrition and a balance of investment avenues. Create a balanced and diversified portfolio and losing money on investments would be a thing of the past.
7) Factor in Inflation
Remember that inflation always eats into the purchasing power of money. Moreover, inflation is a reality and if the economy is growing, there would always be inflation.
So, when you invest, factor in this inflation. Invest in avenues that give you inflation-adjusted returns, i.e. returns that have a positive value even after factoring in inflation.
If you invest in avenues where the returns are not inflation adjusted, you would ultimately lose money even though the avenues give returns because such returns would have a low real worth. For example, say a fixed deposit scheme gives you a return of 6% per annum.
If the inflation in the country is 6.5% per annum, the return that you get from your fixed deposits is actually negative.
Let’s see it in monetary perspective.
Rs.100 would fetch you a return of Rs.6 in a fixed deposit scheme. You plan on buying an item costing Rs.6 with the return that you get. Now, after a year, inflation has driven the cost of the item to Rs.7 but you get a return of Rs.6 from the deposit scheme. Is the return worth it especially since you can no longer afford to buy the article that you wanted?
Inflation, therefore, puts a leak into your returns, a leak that can be plugged by choosing inflation-adjusted investment avenues.
8) Review Your Financial Portfolio, Regularly
Another mistake that most investors make is that they invest and forget. This is another reason why they end up losing money on their returns. How many times do you opt for rollover of your fixed deposits on maturity?
Your financial needs keep changing with changing lifestyle. Your financial portfolio, therefore, needs to change to keep pace with your changing needs.
Change is the only constant and if your portfolio is stagnant you would lose out on the opportunities of maximizing your returns. So, make it a point to review your portfolio periodically, at least once every 6 months or a year.
This reviewing helps you make the necessary changes to your investments. You can redeem your investments if the time is right, you can make additional investments into a fund that is performing exceptionally well, or, you can switch around your portfolio to change the investment combinations.
Review and shuffle your portfolio to reflect whatever you think is the need of the hour to keep your investments relevant and to maximize returns.
Do you know why investors lose money even when they try and pick the best investment avenues? Lack of financial knowledge, that’s why and in India, financial literacy is depressingly low.
As per a Standard & Poor survey conducted in the year 2014, more than 76% of Indian adults did not understand the basics of financial planning. Have a look at the numbers of the survey –
Lack of financial awareness is the reason why investors cannot plan their financial right. They have limited knowledge of risk diversification, inflation, interest-earning, etc.
As such, they fail to choose the right avenues that would help them get the best returns on their money. The result – they lose out on returns. Financial literacy is, therefore, the foundation for building an effective financial portfolio. It is the bedrock of your finances and if you get the knowledge part right, you can avoid losing money on investments.
Here are few courses on Koppr Academy that will help you to get the right knowledge in Finance
If financial literacy is not your strong suit, you can take the help of online courses designed to impart the necessary wisdom. We have curated some of the most comprehensive financial courses on different financial instruments and financial planning as a whole. You can take the help of our courses and learn the ABC of finance.
Acknowledging is winning half the battle in investing right. Armed with sufficient financial knowledge, if you avoid the earlier discussed pitfalls, you can create a leak-proof financial portfolio which prevents loss of money either because of losses, tax cuts or improper financial planning.
So, start your financial journey on a strong footing. Learn the basics first – our courses are there to help you. Then start your investment journey. Plan your goals, understand your risk appetite, plan your taxes, invest right, redeem right, have a diversified portfolio and do a periodic review.
Plug your portfolio leaks and avoid making losses by investing right.
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The Indian economy has a plethora of investment options these days with Exchange Traded funds (ETFs) being a very lucrative alternative. Last five years has witnessed a phenomenal 30-times volume growth in the domain of ETFs, attributed to pension funds and increasing investor awareness.Seventeen asset management companies have launched ETFs based on Nifty50, which contributes to 49% of the total market share, as of September 2020.The fund manager purchased stocks from Nifty50, which allowed the fund to offer returns, similar to those of the index. The total AUM of ETF is pegged at INR 2.07 lakh crore as of 31-Aug-2020, out of which nearly half of it was focused on ETFs that were based on the Nifty50 alone. However, retail investment is quite low on this product compared to the mutual funds, which is one of the main retarding factors to its growth. Hence more awareness needs to be created on how to invest in ETFs to foster an upward trending growth curve. Let us explore an investor’s guide to fine out how to invest in ETFs.
ETFs were launched in India in December 2001, though the fund flow in the ETF industry was very scanty till August 2015. Research shows that the effective growth in Nifty50 AUM and in the industry has taken place only in the last five years.
An Exchange Traded Fund (ETF) is basically a fund that pools in funds from several investors and can be traded on the stock exchange or the secondary capital market, similar to shares.
You need to have a Demat account and a Trading account to start investing in ETFs if done via an investment firm. It is a passively managed fund with a designated fund manager and has a Net Asset Value (NAV) like a mutual fund.
Though they are traded like stocks, their individual price is not determined by the Net Asset Value (NAV), instead by the demand and supply mechanism operating in the market.
Since ETFs track benchmark indices, their returns are closely linked to market movements, to overcome most mutual fund investment schemes. The buying and selling of the ETF units are usually done by any registered broker at any of the recognised and listed stock exchanges in India.
Since the units of the ETF are listed on the stock exchange and the Net Asset Value (NAV) varies according to the market sentiments, they are not traded like any other normal open ended equity fund.
The investor has the liberty to trade in as many units as feasible on the exchange, without any kind of restrictions being imposed on them.
To state it very simply, ETFs are investment funds that track indices like the CNX Nifty or BSE Sensex, etc. Hence, when you decide to invest in the shares of an ETF, you are investing in the shares of a portfolio that tracks the yield and return of its native index.
Investing in ETFs does not entail it to outperform their corresponding index, rather replicate the performance of the Index as they depict the true picture of the market.
Are Exchange Traded Funds (ETFs) a Lucrative Option for Investment?
Exchange traded funds (ETFs) are a safe bet for beginner investors due to their innumerable benefits like higher daily liquidity and lower fund fees as compared to the mutual funds. Here’s a FREE course on mutual funds
Few factors like the wide range of investment choices, low expense ratios, high liquidity, option of diversification, low investment threshold etc. make them an attractive investment option for the individual investors.
These special attributes render the ETFs to be perfect options for adopting various trading and investment strategies to be used by new traders and investors. ETFs are a lucrative investment option due to the following reasons:
Diversification of the portfolio –
In today’s volatile market, diversification of the financial portfolio is mandatory and hence the need for ETFs, which can introduce investors to a huge variety of market segments.
You can diversify your mutual fund portfolio by investing in Gold ETFs, by using the price of physical gold as its benchmark. You can also diversify your wealth among ETFs covering different types of investments like commodities or bonds.
High Liquidity due to absence of a lock-in period
Investment in Exchange Traded Funds help in portfolio diversification along with providing liquidity. They are open ended funds with no lock-in period, which gives them the liberty to withdraw their holdings according to their requirement.
Since there is no holding period, investing in ETF is a lucrative investment option.
Cost Efficiency due to Passive Management–
The expense ratio for maintaining the ETFs are comparatively lower as they are not actively managed like majority of the mutual funds.
Since there are no management fees or commissions involved, the incremental value of the overall fund is usually increased.
An ETF held with a low expense ratio can add on to the pay-outs if held for very long. For example, index ETFs just track the index, so the portfolio manager does not need to manage the fund. This calls for a lower management expense ratio (MER).
Single and transparent transactions –
Investing in ETFs require you to make one single transaction similar to owning a mini portfolio.
Therefore, when you have to track the performance of this portfolio, for example if you have invested in a Gold ETF, you would need to track the price movements of gold only as a daily commodity, which is much easier for the investor.
Also most of the ETFs publish their holdings on a daily basis, hence you can find out their holdings, their relative weightage in the funds and if there has been any movement, thereby fostering transparency in the financial chain..
Offer flexibility to buy and sell –
Unlike mutual funds, ETFs can be purchased and sold from an investment firm or at the stock exchanges on a daily basis, similar to the intraday trading mechanism.
They have the flexibility to be bought short and sold at a profit margin in a day during the market operating hours, at the current market price at the time of the transaction.
Professional Fund Management –
Though ETFs maintenance or operation costs are pretty low, they are very professionally managed.
Tax Efficiency –
ETFs are considered to be equity oriented schemes, which entails them to follow a taxation norm similar to any other equity related investment scheme.
Here are the 5 Proven Strategies for Financial Planning. Watch Now
Types of Exchange Traded Funds
With several options among ETFs available in the financial markets these days, consumers tend to get perplexed in which to invest.
Hence there are 4 broad categories of ETFs that one can invest in, namely:
Equity ETFs – Equity ETFs usually track the movement of sector or industry specific stocks. Here the performance of the index or the specific sector is replicated by investing in stocks accordingly.
International exposure ETFs – There are few ETFs that track stock indices of foreign stock markets. Since they give the investors an opportunity to gain exposure in some international markets, they are actively involved in weaving the growth stories for few economies.
Debt ETFs – Few exchange-traded funds try trading in fixed-income securities.
Gold ETFs – Gold investment is always considered a great hedge against currency fluctuation and a volatile market. However, investments in physical gold is faced with several concerns like quality, security, resale, taxation, etc. Hence, Gold ETFs are a safe option where you can invest in gold bullion, thereby having gold in your portfolio without the risk or fear of investing in physical gold.
Factors to be kept in mind before you decide to invest in an ETF
Today’s financial market is flooded by too many options even within the ETFs. There are four factors that one must consider before you decide to invest in an ETF:
Trading Volume of the ETF – You should chose an ETF with higher trading volume if you need liquidity and a good price for the units traded on the stock exchange.
Class of the ETF – Since ETFs are of four types, equity, international, gold and debt, once a category is finally selected, its sub category also needs to be decided. The specific sector ETF or their market capitalization needs to be focused upon if you are investing in an equity ETF.
Lower Expense Ratio – Usually the expense ratio of an ETF is much lower than an actively managed fund. But even then many fund houses offer more discounts on the expense ratios to attract more investors, thereby increasing the chances of higher returns.
Lower Tracking Order – ETFs usually track an index as they invest in securities that comprise the index in a manner that the returns are almost similar to those offered by the index, thereby making some differences feasible between the returns offered by the index and the ETF. Tracking error usually identifies variance in the performance of the ETF in comparison to the underlying index. If the tracking error is lower, the returns of the ETF will be closer to that of the index. Therefore, you should always invest in ETFs with a lower tracking error.
Comparison between Mutual Funds, Stocks and ETFs
A detailed study on ETFs has been quite helpful in understanding the market and drawing a comparison between them as against the mutual funds and stocks:
Exchange Traded Funds
A financial set up comprising of a pool of money collected from many investors to invest in different securities like bonds, stocks, money market vehicles and various other assets.
The investment capital raised by a company through the issue of shares, thereby signifying some ownership in that company for the investors.
An exchange traded fund (ETF) is an asset class consisting of a collection of securities like stocks, that track an underlying index or a specific sector.
Though the exposure is diversified, there are market specific risks.
Very risky proposition as the performance of the stocks are directly proportional to the company’s performance.
Though the asset class is diversified, it however carries market related risks.
Mutual fund trading is done only once a day after the financial market is closed.
Can be traded throughout the day.
Can be traded throughout the day.
Degree of Control
Not very highly regulated or controlled investment.
Very highly controlled investment.
Higher control on these type of investments as compared to mutual funds but lesser than stocks.
Tax Implications on ETFs
The taxation policy applicable on ETFs are quite unique as compared to the tax treatment meted out to mutual funds.
The index ETFs and sectoral ETFs are considered as equity-oriented schemes from the tax perspective. They have the unique selling proposition of creating and redeeming shares with in-kind transactions, which are not rendered as sales.
Since there is no sale involved, they are not taxable.
However, if you plan to sell your ETF investment, this transaction will be taxable. The tenure of holding onto this ETF investment will decide if it was a short-term or long-term profit or loss.
Therefore, research reveals that short term capital gains from ETF units held for less than one year are taxed at 15% vis-a-vis the long term capital gains on ETF units being held for more than one year, being taxed at 10% without any indexation benefit.
If you are a new investor planning to enter the Indian financial market, ETFs consisting of a basket of securities offer a well-diversified approach. They are a much better proposition than purchasing the stocks directly for first time investors.
You should do a thorough research on the investment options available and devise a suitable investment plan based on your financial objectives, tenure to invest, intricacies of investing in ETFs and your risk tolerance level.
Since these funds are passively managed, they are cost efficient and usually match the returns offered by the index.
Also if you are an aggressive investor, ETFs are still a good option for stable investments if utmost planning is done well in advance.
Thus, with adequate knowledge and research, all the first time investors should allocate some of their funds to ETFs for a better wealth creation.