Investment Planning Advice for Indian Middle Class

Investment Planning is the key to sucessful investing. It is a scientific process, which, if done in the right sprit, can help you acheive your financial goals. Here are the basic steps of Investment Planning

Step 1 : Identify your financial needs and goals

The starting point of a sound investment plan is to begin with a clear understanding of you financial needs and goals. Typically, any financial need or goal would translate into determining the tenure of your investment (investment horizon). All investment needs and goals can therefore be translated into short-term (less than 1 year), medium-term (more than 1 year) and long-term (more than 5 years). Here is an example of the financial goal of a typical household (a couple with two childrens).
Financial Goals Expected Cost (at today’s prices in Rs) Time Frame Investment Horizon
Son’s computer 0.5 Lakhs Next month Short-term
Daughter’s school admission 0.35 Lakhs 6 months Short-term
Vacation 0.5 Lakhs 1-2 years Medium-term
Buying a second car 5 Lakhs 2-3 years Medium-term
Son’s education 2 Lakhs 10-12 years Long-term
Daughter’s education 2 Lakhs 12-15 years Long-term
Retirement 20 Lakhs 20-25 years Long-term

Step 2 : Understanding investment choices

There are three basic investment categories: Equity, Debt and Cash. Any investment can be classified into one of these three categories, or asset classes. The key to investment success lies in understanding how each asset class performs over the various investment horizons, the choices within each category and the risks involved in making investment decisions in each of these choices.

Equity or Stocks are ownership shares investors buy in a corporation. When you make equity investments, you become part-owner (to the extent of your shareholding) of the company you have invested in. However, there is no particular rate of return indicated while investing. The current value of your holding is reflected in the price at which the stock/share is traded in the stock markets. Hence, these constitute a relatively riskier form of investment.

Debt instruments or Bonds are loans investors make to corporations or the government. They promise a fixed return at the time of making the investment. Also the promise of getting the money back is dependent on who is making the promise. In case of the Government, the promise will certainly get fulfilled, but if the issuer of debt is a company or an institution, the quality of the issuer needs to be adjudged, to ascertain its ability to keep the promise. Debt investments, therefore, provide you with the promise that your principal will be returned along with the interest payable thereon.

Cash includes money in bank savings accounts and other liquid investment options.

Asset Classes Instruments Risk
Cash Savings deposits in a bank, Liquid Mutual funds Low
Debt GOI Relief Bonds, Public Provident Fund, National Savings Certificate, Company Fixed Deposits, Debt-based Mutual funds ,Debentures/Bonds Low to Medium, depending on the type of issuer. In case the issuer is Govt, the risk of default is negligible
Equity Equity-based Mutual Funds Stocks/shares issued by various companies High

Step 3 : Decide an appropriate mix of various investment choices (Asset Allocation Plan)

Making an asset allocation plan is about determining the proportion of investments in each of the three basic asset classes. Essentially this depends upon your profile as an investor. Whatever stage of life you are at, you would need to invest part of your money for security and liquidity. A part of your investments should generate regular income and part of it should contribute to growth and capital appreciation. The proportion however, will vary based on individual goals, time horizons available to meet those goals and one's risk profile (the tolerance reaction to any down turn in the stock/debt markets).

The key to investment success lies in determining the appropriate mix of the above mentioned categories and not just the individual investments that are done within each category.