Guide To Fund Your Financial Plans

2.1 Financial Plans

Akansha and Abhijeet, both in their 20s, recently married and excited about planning their life together, heard about a free financial-planning seminar taking place at the local hotel. A local financial planner taught the seminar. One of his points was, “If you want to retire by the age of 65, you need to save at least 12 percent of your income every single year between now and retirement . . . the longer you wait to start saving, the more painful it’ll be.”

For the couple, the seminar was a wake-up call. On the drive home, they couldn’t stop thinking and talking about their finances and their future. They had big plans: They wanted to buy a home, they wanted to send the not-yet-born kiddies to college, and they definitely wanted to retire by age 65. And so it was resolved: A serious investment program must begin right away. Tomorrow, they’d fill out two applications for mutual fund companies that the financial planner had distributed to them.

Within a week, they’d set up accounts in five different mutual funds at two firms. No more 3-percent-return bank savings accounts – the funds they chose had been returning 10 or more percent per year! Unlike most of their 20-something friends who didn’t own funds or understand what funds were, they believed they were well on their way to realizing their dreams.

Although I have to admire Akansha and Abhijeet’s initiative (that’s often the biggest hurdle to starting an investment program), I must point out the mistakes they made by investing the way they did. The funds themselves weren’t poor choices – in fact, the funds they chose were solid: Each had competent managers, good historic performance, and reasonable fees

2.2 Mistakes Made

The following points are the biggest mistakes they made:

• They completely neglected investing in their employers’ Provident Fund plans. They missed out on making tax-deductible contributions. By investing in mutual funds outside provident fund and tax saving funds, they received no tax deductions.
• They were steered into funds that didn’t fit their goals. They ended up with bond funds, which were decent funds as far as bond funds go. But bond funds are designed to produce current income, not growth. Justine and Max, looking to a retirement decades away, were trying to save and grow their money, not produce more current income
• To add tax insult to injury, the income generated by their bond funds was fully taxable because the funds were held outside of tax-sheltered funds. The last thing Akansha and Abhijeet needed was more taxable income, not because they were rolling in money – neither Akansha nor Abhijeet had a high salary – but because, as a two-income couple, they already paid significant taxes.
• They didn’t adjust their spending habits to allow for their increased savings rate. In their enthusiasm to get serious about their savings, they made this error – probably the biggest one of all. Akansha and Abhijeet thought they were saving more – 12 percent of their income was going into the mutual funds versus the 5 percent they’d been saving in a bank account. However, as the months rolled by, their outstanding balances on credit cards grew. In fact, when they started to invest in mutual funds, Akansha and Abhijeet had Rs.100000 of revolving debt on a credit card at a 14 percent interest rate. Six months later, their debt had grown to Rs.200000. The extra money for investment had to come from somewhere – and in Akansha and Abhijeet’s case, it was coming from building up their credit card debt. But, because their investments were highly unlikely to return 14 percent per year, Justine and Max were actually losing money in the process. No real additional saving was going on – just borrowing from Visa to invest in the mutual funds.
  This story is not to discourage you but to caution you against buying mutual funds in haste or out of fear before you have your own financial goals in mind.
• One thing to remember before you dive in: Don’t become obsessed with making, saving, and investing money that you neglect what money can’t buy: your health, friends, family, and exploration of career options and hobbies

2.3. Plan Before Investing

The single biggest mistake that mutual fund investors make is investing in funds before they’re even ready to. It’s like trying to build the walls of a house without a proper foundation. You have to get your financial ship in shape – sailing out of port with leaks in the hull is sure to lead to an early, unpleasant end to your journey. And you have to figure out what you’re trying to accomplish with your investing.

Some Important Point:

A. Payoff Debt– Consumer debts include balances on such items as credit cards and auto loans. If you carry these types of debts, do not invest in mutual funds until these consumer debts are paid off. I realize that investing money may make you feel like you’re making progress; paying off debt, on the other hand, just feels like you’re treading water. Shatter this illusion. Paying credit card interest at 14 or 18 percent while making an investment that generates only an 8 percent return isn’t even treading water; it’s sinking.

You won’t be able to earn a consistently high enough rate of return in mutual funds to exceed the interest rate you’re paying on consumer debt. Although some financial gurus claim that they can make you 15 to 20 percent per year, they can’t – not year after year. Besides, in order to try and earn these high returns, you have to take great risk. If you have consumer debt and little savings, you’re not in a position to take that much risk. Not only should you delay any investing until your consumer debts are paid off, but also you should seriously consider tapping into any existing savings (presuming you’d still have adequate emergency funds at your disposal) to pay off your debts.

B. Figure out your financial goals– Mutual funds are goal-specific tools (, and humans are goal-driven animals, which is perhaps why the two make such a good match. Most people find that saving money is easier when they save with a purpose or goal in mind – even if their goal is as undefined as a “rainy day.” Because mutual funds tend to be pretty specific in what they’re designed to do, the more defined your goal, the more capable you are to make the most of your mutual fund money.

Granted, your goals and needs will change over time, so these determinations don’t have to be carved in stone. But unless you have a general idea of what you’re going to do with the savings down the road, you won’t really be able to thoughtfully choose suitable mutual funds. Common financial goals include saving for retirement, a home purchase, an emergency reserve, and stuff like that.
Another benefit of pondering your goals is that you better understand how much risk you need to take to accomplish your goals. Seeing the amount you need to save to achieve your dreams may encourage you to invest in more growth-oriented funds. Conversely, if you find that your nest egg is substantial, given what your aspirations are, you may scale back on the riskiness of your fund investments.

Analyse Savings

The vast majority of Indian’s haven’t a clue what their savings rate is. By savings rate, I mean, over a calendar year, how did your spending compare with your income? For example, if you earned Rs. 4,00,000 last year, and 3,80,000 of it got spent on taxes, food, clothing, rent, insurance, and other fun things, you saved Rs.20,000. Your savings rate then would be 5 percent (Rs20,000 of savings divided by your income of Rs.400000). If you already know that your rate is low, nonexistent, or negative, you can safely skip this step because you also already know that you need to save much more. But figuring out your savings rate can be a real eye-opener and wallet closer.

To save more, reduce your spending, increase your income, or both. This isn’t rocket science, but it’s easier said than done.

2.4.Access the risk you’re comfortable with

Think back over your investing career. You may not be a star money manager, but you’ve already made some investing decisions. For instance, leaving your excess money in a bank savings or checking account is a decision – it may indicate that you’re afraid of volatile investments.

How would you deal with an investment that dropped 10 to 50 percent in a year? Some of the more aggressive mutual funds that specialize in volatile securities like growth stocks, small company stocks, emerging market stocks, and long-term and low-quality bonds can quickly fall. If you can’t stomach big waves in the financial markets, don’t get in a small boat that you’ll want to bail out of in a big storm. Selling after a big drop is the equivalent of jumping into the frothing sea at the peak of a pounding storm.

You can invest in the riskier types of securities by selecting well-diversified mutual funds that mix a dash of riskier securities with a healthy helping of more stable investments. For example, you can purchase an international fund that invests the bulk of its money in companies of varying sizes in established economies and that has a small portion invested in riskier, emerging economies. That would be safer than investing the same chunk in a fund that invests solely in small companies that are just in emerging countries.