Ad hoc investing is like travelling blind. You will still get somewhere, just not where you intended.
Every morning, Ramesh would pray: “God, help me win a lottery.” This went on for many years till prayer-weary God deigned to pay him a visit. What did He find? The man had never even bought himself a lottery ticket. Most of us fantasise about a lot of money without a clue what we would do with it. It’s a bit like taking a cab to nowhere. If you are chuckling with superior glee, ask if you do the same with your money. It might sober you down, and that’s a start.
All my clients get a sheet of paper when they come to my office. They are asked to list their financial goals, all those things they have to do, want to do, would love to do with their money. In other words, they are asked to set down their financial goals—and dreams that money can buy. When they are couples, husband and wife get separate sheets. What do you think happens? Most of them have been nowhere near trying to list their goals. A few manage “a house, a car, children’s education,” but not much else. Even couples, evidently planning a future together, scratch around and often come up with very different lists.
What does the cabbie do if you can’t tell him where you want to go? He either says: ‘sorry, find someone else’ or, more likely, takes you for a merry ride. I wouldn’t blame him: he’s still making an honest living. Likewise, people who don’t set themselves (financial) goals end up lining others’ (agents/distributors/bankers et al) pockets.
Investors who don’t set themselves goals or are vague about them, and have not assessed the feasibility of their targets, risk jeopardising even the most important ones. And worse, they take on a lot of avoidable anxiety. If you took a train and didn’t know where to get off, you’d fret at every station. Just look at the number of TV shows and newspaper/magazine columns trying to answer when/whether to buy/sell/hold. The demand is seemingly insatiable. The poor anxious sods glued to these TV shows don’t know why they have invested. No wonder, they burst a few blood vessels every time the market drops a few hundred points.
The markets are inherently volatile. At any point in time, there will be some asset class going up and some other going down. Aligning our investments to an intrinsically flighty market is to make our investment portfolio dance the same mad dance in tandem. Prudence lies in aligning our finances to our life situation, in investing on the basis of our means, needs and goals. If you knew you were investing in the stock market to, say, finance your eight-year-old daughter’s education in an Ivy League college, you wouldn’t fret and fume every time the Sensex shed a few hundred points. You’d be safe in the knowledge that 10 years down the line, when you need the money, your corpus will have grown enough to finance your ambition.
Now, sending her to an Ivy League college may be high priority, but it is still just one of many financial goals you’ll have. You’ll want a house of your own, another car two years down the line, maybe a lavish wedding for your daughter, perhaps a trip to Brazil or Cuba or the West Indies, and so on. There’ll be unforeseen expenses too: god forbid, your dependent elderly parents might need to be in hospital for a stretch, the house you live in may sustain damages in an earthquake… You never know, some nasty surprise might await you at some turn in life, which will drain you financially, unless you’ve provided for such events. And the way to do that is to have in place a financial plan.
The discipline of Financial Planning spans far more ground than just investing. It is about taking a holistic look at your finances, and channeling your monetary resources to meet your goals. Resources equal real money, which comes in the shape of salary, professional fees, profits in business, interest on deposits, dividends from stocks, rent from real estate etc. The financial planning exercise is like keeping a four-wheel vehicle in perfect working order, where the four wheels are: your income, your expenses, your assets (investments) and your liabilities (loans). A lot of us are prone to tending to one wheel at a time—either worrying about how much money we make and how to make more, or how to cut our ballooning expenses, or what stock to buy or sell, or how to manage our EMIs, and so on. And in so doing, ignore for the time the others, with sub-optimal results at their best and disastrous consequences at their worst. The trick, to return to the car metaphor, is to tend to all the wheels simultaneously, synchronously. Enter financial planning.
Start by making a family budget, a simple statement of your income and expenses. It might seem a painful exercise, but its necessary spadework to get to a state of financial wellbeing, the only way you’ll even start getting on top of your finances. Nobody ever said creating wealth and then preserving it was a walk in the park. The budgeting exercise will reveal your investible surplus, which you can then plough into planned investments.
Investing is not a one-time exercise either. In your active career years, when you are generating regular incomes, you’ll be periodically funneling your surpluses into a diversified bundle of investments. To ensure that your corpus is growing at a healthy clip, you also need to track your investments—not maniacally every day (that, in fact, is counter-productive), but as a rule of thumb for a couple of hours every quarter. Most people are at the two extremes of tracking behaviour—obsessive or oblivious. You need to find a balance. While we are still on the subject of investing, just remember that investible surpluses are what you’re left with after retiring expensive debt—it is best to first repay your loans.
PROTECTION, ACCUMULATION, DISTRIBUTION
If the ultimate aim of managing your finances is to create and preserve wealth, then this end is ideally served through a three-step process—protection, accumulation and distribution. Lets understand this better through the illustrative story of two friends, Manish and Sanjay.
Manish and Sanjay started their career together in the same company. They were both management trainees with the same payscales. Both believed in saving and investing for a rainy day. Manish first set aside funds for contingencies like a possible job loss and bought himself medical insurance. At the end of the year, he did not have any surpluses to invest. From the second year onward, he invested regularly through a Systematic Investment Plan (SIP) with a mutual fund. Sanjay, on other hand, started investing as soon as he got his first salary. He diversified his portfolio across various asset classes.
At the end of five years, Manish had a contingency reserve, medical insurance and additional savings of Rs 50,000, while Sanjay had savings of Rs 85,000. He was visibly chuffed with himself. After about five years, there was an epidemic. Both fell ill, and had to go on leave without pay due to their prolonged illness. Manish had his medical insurance to meet the cost of treatment, and was able to dig into his contingency reserve to tide over the no-pay period. Sanjay, on the other hand, wiped out his savings. At the end of Year 6, Manish still had his savings intact while Sanjay had only Rs 15,000 left.
The moral of the story is this: while creating any kind of wealth creation plan, ensure first that your protection strategies are in place, that your savings/investments will not be wiped out like Sanjay’s if an unforeseen tragedy strikes. Earmark money to create a contingency reserve and insure your life (if you have dependents), your health and your property (house with its contents, car, jewellery and all other assets that will be replaced at great cost). For good measure, get yourself accident insurance as well. Once you’ve done this, you’re set for Step 2—accumulation.
The composition of the investment portfolio you create over time will, of course, depend on the kind of goals you set for yourself—you might want your own house before you turn 30 and you might want retire at 40. If you ignore the extreme cases—and the average Joe certainly doesn’t dream of retiring at 40—you’ll find that all prudent investors observe some common rules. They diversify their investments across and within asset classes (debt, equity, real estate, bullion etc.), their portfolios will look most aggressively oriented in their early career and progressively less so as their careers mature and their familial responsibilities grow, and on approaching retirement, they will start migrating the bulk of their portfolio to income-generating investments. They have now taken Step 3—distribution.
In your retirement, you’ll be living of the corpus you created in your active career years—on returns from the corpus and on the capital itself. This is the distribution phase of retirement. Now that you don’t have a job to keep, now that your children are all well settled in their careers, now when your life’s goals have been met, you will want to relax and indulge yourself a trifle. You’ll want to take that long vacation that you could only dream of in your career years, you’ll want to lavish your grandchildren with gifts, you’ll want to… All this costs. As does managing your health in your old age. So, be sure to salt away enough to pay for your geriatric needs and the odd indulgence before you go about distributing your wealth among your children and charities. You never had to lean on anyone, and chances are you’ll prefer it stays that way.
The author is a Mumbai-based financial planner and wealth manager.