As life evolves around us, one of the facts to notice is that as we become older our requirements for finances for meeting various life’s needs like building a house, child’s education, child’s marriage or planning one’s retirement increase. It is also a fact of life that very few of us really start planning for all these needs which are sure to come in the future early enough. Almost everybody starts looking at these things in their mid 30’s or early 40’s when these financial needs look nearer than they were earlier. Hence, it is important to start looking at financial planning early in life to ensure that one does not get into a worrisome situation later. As the popular saying goes ‘one should save for the winter while some summer is still left.’

Most of us are familiar with only a few savings instruments like bank deposits, provident fund, company fixed deposits or at the most government bonds. However, the potential universe of financial savings instruments and the risks associated with them is much wider and vaster and can provide for more significant avenues for deployment of long term savings, provided one does it in a scientific and disciplined manner and with proper wisdom and advice. At a very basic level to complete the entire financial plan, an individual needs to ask some basic questions. We have listed down these questions here as well as attempted to answer them to the best of our ability.

The first question obviously is who should save in the manner that we are going to talk about. Everybody who has money in a bank can potentially optimise their return by thinking about what is it that they want from this money which has been put away for the future and what kind of liabilities will come in the years ahead. Hence, the answer to this question is really everybody who expects that as life evolves, financial requirements and responsibilities will rise has the need to study a proper financial savings plan (FSP).

The second question that comes to people’s mind is when to save. As has been mentioned earlier, often young people think that since they have significant period left as far as their earning years are concerned ahead of them, they need not think about saving. This is a very big fallacy. It is known from demonstrated calculations that the earlier you start saving the more likely it is that you will meet your life’s financial goals. So a person should start saving as early as possible and convenient and hopefully save for a long period of time so that in life’s autumn years these savings will provide them with a dignified standard of living and absence of financial worries.

The third question that a person then asks is fine if I am ready to save, what are the basic things that I need to understand. At the basic level there are mainly two types of financial assets. Either your assets can be in debt securities or in equity securities. Debt securities are in the nature of fixed yield instruments and if held to the maturity give the coupon return earlier indicated. Obviously, in the case of debt securities if lending has been done to a company or an entity which is not of high quality, at times such companies can also default either on the payment of the coupon / interest or of the principal amount itself. In the case of equity securities, typically, yields which are paid in the form of dividends are very low (in the region of 2 to 3%). However, the share prices of these equity securities (listed in stock markets) move up and down significantly and the investor has to bear the complete risk of any downward movement while at the same time also benefits from any upward movement of the securities.

Having understood these basic facts about debt and equity securities, let us look a little more in detail at the various options available in each of these financial asset classes. In the case of debt securities, typically what happens is that we as investors are in giving money to an entity which indicates a particular yield that they would want to give on these instruments. This entity could either be a company or a bank or Government of India. Thus, you have various instruments like fixed deposits (in the case of banks and corporates), bonds (through which lending is done to companies) and Government of India securities (through which Government of India borrows from the general public etc.). Thus, one can buy a mixture of these securities if one wants to invest in the debt asset class. Alternatively, one can give money to mutual fund managers who on behalf of clients invest in a mixture of these to optimise long term returns. Similarly, in the case of equities while there are many listed companies and they need to be studied in detail before one invests in them, mutual funds offer a convenient way of investing. Mutual fund managers study the fundamental performance potential of various companies and then decide to put a combination of these in their funds. Based on these asset classes, broadly there are two types of funds, either debt oriented mutual funds or equity oriented mutual funds. One mutual fund house would typically have several funds having a combination of debt securities or a combination of equity securities and in some cases hybrid funds which would have a combination of debt and equity securities. These are discussed in some more detail in the next paragraph.

After having understood the basics of various financial assets available, a person normally would ask what combination of these should I invest in. This is the most difficult question to answer as the requirement would vary from case to case based on several parameters. These parameters would include things like one’s personal age, family lifecycle, expectation of future financial liabilities as well as the current savings potential out of the disposable income. All these need to be considered before deciding on a financial plan for the future years. However, for those who don’t want to get into the complexities of the financial plan, there is a simple thumbrule. Out of the total income that a person wants to save, the thumbrule says that save 80 minus your age in equity oriented funds and the remaining in debt oriented funds. What this means is that a person at the age of 30 can invest as much as 50% of the monthly amount that he or she intends to save in equity oriented funds and the remaining should be saved in debt oriented funds. However, as a person ages and say at the age of 50 the percentage savings in equity oriented funds should come down to only 30% of the monthly savings while correspondingly the savings in debt oriented funds should go up to as high as 70% in this phase. Thus, as a person ages and correspondingly his or her risk taking appetite comes down, the asset class which is higher risk viz. equity should also have lower and lower allocation.

Let us also discuss the characteristics of debt oriented funds and equity oriented funds. Debt oriented funds typically have maturity profiles which are in the region of a few months to a few years. What this means is that they buy securities which have maturity in some cases of a few months and in some other cases have longer maturity in many cases between 5 and 10 years. Thus, one would intuitively guess that funds which have a longer maturity have somewhat higher level of risk and correspondingly debt funds with lower maturity would have correspondingly lower level of risk. Funds with lower maturity are called liquid funds or short term bond funds and funds with longer term maturity are called income funds and those investing in government securities are called Gilt funds. Out of the debt fund allocation, a person would be well advised to invest 50% in liquid funds and another 50% in bond funds.

As has been mentioned earlier, equities can move up and down and these movements at times are extremely volatile. However, it has been seen that if a person can save in equities over long periods of time, then expectations of returns have been superior to other financial assets. To give you an example, in January 1994 the benchmark BSE index was approximately at a level of 4,000. Over the past 15 years, the index has climbed and in January 2008 touched the level of 21,000 (At present the Sensex is around 15,000 levels). Thus, arguably over these 15 years if somebody had bought stocks in the same proportion as those in the index, the appreciation would have corresponded to this significant movement of the BSE Sensex index over this period of time. However, a note of caution is warranted to say that one should put only that money which one does not need for at least 5 years, only that money which if some losses occur does not cause concern to an individual in the short term and only that money which can be identified as risk capital in equity funds. Those investors who do not want to save for long term (a minimum of 5 years) are well advised to not enter equity funds. In the case of equity funds, investors are advised to stick to diversified broad market funds unless they are equipped to analyse various funds in great detail. Thus, to again take the example of the 30-year old person who has invested 50% in diversified equity funds of maybe three fund houses and has put approximately 25% (50% of the remaining 50% to be invested in debt funds) in liquid funds and similarly another 25% in bond funds.

Those motivated to consider investing in the funds of the nature mentioned above will ask how to go about making these investments. In most cases, the process of investing has become very simple now and many funds offer the facilities of investing in a number of cities in the country. The process of investing involves filling up a form and submitting some relevant documents apart from the cheque of the amount that one wants to invest. In case a person wants to choose a particular fund house, the best way to do is to look at the names of various fund houses and find a few with whom one has comfort. However, investing in too many schemes also becomes cumbersome and one should restrict oneself to investing in not more than three fund houses. Details of the schemes and various fund houses as well as those of distributors are available on the website of the Association of Mutual Funds in India (AMFI) (www.amfiindia.com).

An important mention needs to be made again of how to go about investing once one has decided on the fund house as well as the individual funds and one has located the exact way of investing. The best way to invest in funds is to invest a fixed amount every month in a percentage of allocation as mentioned above for debt and equity funds over a long period of time. This process of scientific and disciplined monthly investing over long periods (again we emphasise a minimum of 5 years), has known to benefit investors significantly. Thus, the argument we are making is to look at these opportunities as savings opportunities just like bank deposits and not be swayed by short term movements of either equity or bond markets. The websites of several funds (which can be accessed through the AMFI website mentioned above), give several ways of calculating returns available in the past from their various funds. One should also not get carried away by the hype that sometimes surrounds rapid market movements and continue this disciplined and scientific process of investing mentioned above.

The last important question that a person asks is when do I sell. Our opinion on this is that investing should be done only for the long term and on the basis of projections of future financial liabilities. As and when these financial liabilities occur, one should encash one’s savings and proportionately meet these liabilities. Most funds above are open ended in nature. This means that in any case if there are any emergencies the person can take out their money. However, since markets are prone to sharp movements in the short term, the corresponding effect would be reflected in one’s fund appreciation or depreciation. Care should be taken to invest in only open ended funds especially if one is expecting that in the case of some emergency one may need to withdraw this money.

We have mentioned above that a disciplined scientific process of long term financial savings is now required for every person as future financial liabilities are certain and are likely to be significant. The process of investing is very simple and can be matched with one’s lifecycle profile and savings capability at present. Several easy and convenient options are available through mutual funds to bring these savings into effect. Individuals are advised to invest a fixed amount every month in the process mentioned above over a long period of time and ultimately benefit from the growth that the Indian economy has to offer in the years to come.