Saving & Investment – Steps For Financial Freedom
Investment is a powerful word. Powerful enough to alter the course of your life in the times to come. A good and timely investment can give you returns that can help you lead a comfortable life when you retire from your work life, it can fund the higher education of your child, get you to go on a dream vacation with your family or maybe buy your dream house on an exotic island. There could be innumerable other reasons for which your investments can provide the required funds.
So far so good. This, however takes us to next questions – Should I make investment plans with high returns? Should I look at investing with low risk? How much and where should I invest?
As far as how much is concerned, this is a question that you need to answer yourself. To invest, you need to save some amount from your income. Often, when you have money in pocket and you are making a trip to Walmart or Macy’s, we come across tempting products and end up shopping items which you may not really need. Follow the motto of ‘earn more, spend less’ and the difference between your income and spending will determine the quantum of saving that you achieve. This saving becomes the source for investment that you can make. Financial experts suggest a thumb rule of saving 60% of your income on a regular basis. Also, this should start from the moment you start earning.
Procrastination needs to be avoided.
In a nutshell, the earlier in life you start to save, the more you have for investment. Saving early in life also gets you to invest over a longer period, thereby, reaping higher returns.
Where Should You Invest?
This is a simple but serious question with not so simple answer, merely because there are many investment options available to select from, each with its merits and constraints. Called the vehicles or instruments of investment, some of these offer more returns than others, some are great for long term investments while some offer great value in short term, some may lock your money for a longer period while others may offer more liquidity.
Essentially, the decision about whether to invest in one or multiple instruments and if latter, what should be the percentage allocation of your available funds to each of the instruments, depends upon a few factors:
Available Time & Saving: You need to know the amount of time that you have until you need to access your money. How long do you have say for retirement or your child’s education for which you will need your money? You also need to be clear about the amount of money that you can save and make available for investment each year. For instance, if your retirement is due in 5 years, you need to invest more amount in an investment vehicle that matures quickly with good returns.
Risk Taking Ability: Every investment vehicle has its own level of volatility and the risk factor that it brings along. The market forces impact the performance of each investment vehicle in terms of good or bad returns. Based upon the time available (as above) and your personal comfort level, you need to decide your approach if you want to take low, moderate or high risk or a mix of these.
Objective of Investment: Your investment objective needs to be defined – are you looking at capital growth? Or do you want to preserve your capital and look at income generation? Or do you wish to have a balance between both these options?
The above factors will play an important role while building and managing your portfolio of investments, which means, allocating your savings in the right investment vehicles in adequate amounts for appropriate duration.
Let us look at some common…
Instruments of Investment
Broadly investment can be classified in two categories – Financial and Non-Financial investment Instruments. Some of these instruments of investment are given below.
Equity/Stock: Investing in this gives you a partial ownership in a company that has put out its shares in the market to be bought by investors. These shares are traded in stock markets every day and thus, the value of each share is highly volatile and, therefore, risky. However, investing in equities of blue chip companies is a good long-term investment as over a longer period of time the returns are usually higher than other investment options.
Bonds: Bonds are usually low risk, fixed duration loans that you extend to private companies, governments or government institutions which are looking to raise capital. These are essentially IOU certificates which carry fixed rates of interest, fixed date of repayment and also fixed time for payment of interest – yearly or half yearly.
Mutual Funds: instead of buying individual shares, many people pool their money together and invest in equities and bonds through a mutual fund which is managed by a professional investment/money manager. This allows flexibility to enter the market with smaller investment, has the risk diversified among different investment vehicles and is managed professionally without you having to bother about the same. Hence, it is a popular instrument.
Certificates of Deposit/Term Deposit: Certificates of deposit (CDs) bank deposits for a fixed term i.e. they have a fixed maturity date and earn interests from the bank. Long term deposits earn higher yield than short term deposits. These are usually at the lowest end of the risk-return continuum.
Liquid Investment Options:
- Savings account – Although this cannot be considered an investment vehicle, this is the account in a banking institution where people park their money even before they think of or are planning for investment. Earning a nominal rate of interest, the Savings account is highly liquid which means that you can quickly and easily withdraw money from your account whenever you are in need;
- Money Market Account – Similar to savings account in terms of liquidity as well as the rate of interest that it offers, the money market account’s funds are invested in Certificates of Deposit, U.S.Treasury Bills and other liquid investments.
Real Estate: Considered as a classic investment opportunity, real estate often gives better returns than stocks, bonds and mutual funds over a long term. Some factors like the location of the real estate property, nature of the property – residential or commercial and the duration for which the investment is made play an important role in determining the returns. Real Estate, though, may not be a good option if looking for liquidity.
Gold: The precious yellow metal is a controversial investment vehicle. While for some it is an investment which creates a security to tide over economic shocks or emergency requirements, a majority of the people do not consider Gold as an investment vehicle, at all. The argument is that unlike other investment vehicles, Gold does not crow your capital or gives you returns. A pile of gold remains just that and the value fluctuates according to market forces of demand and supply.
It is great that you are earning a fantastic salary or making an awesome income from your business, however, if you are not saving and investing a substantial part of your income in instruments to earn more, it may not be feasible for you in the long run. Spending everything you earn or keeping your savings at home may give you momentary happiness but result in a long term discomfort when your resources may not be enough to even fulfill your needs leave aside fulfilling your desires.
It is, therefore, imperative that you think ahead, plan long-term goals and invest your savings in such a way that you attain financial wellness and never fall short of this essential resource called money. As they say, ‘money may not be everything but happiness alone is not enough to survive.’