Most of us spend more than half of our lives working and saving money. However, most of us spend almost no time planning to make that hard-earned money work more effectively for us. Your success as an investor depends upon your ability to choose the right investment options. This, in turn, depends on your needs, wants and dreams.

I would like to discuss some investment basics that every investor should know while planning their investments. Investment planning isn’t a way to get rich quick, but is a disciplined execution of your lifetime plans.

Investment - Consumption Cycle

By making an investment, you are using money that could otherwise have been consumed. You are sacrificing the pleasures of buying a car, taking a vacation, renovating your home etc. There ought to be some reward for this sacrifice. The reward is that you expect to get back more than what you have put in. You can then consume the amount that you get back. Thus investment refers to a commitment of funds to one or more assets that will be held over some future time period. In simple words, anything not consumed today and saved for future use with some risk can be considered an investment. Thus future consumption is the main motivation of an investment made today. Investing creates wealth and wealth is a driver of consumption. More wealth means more consumption, while less wealth leads to less consumption. Thus all the three: investment, wealth, and consumption are interrelated. This is the investment consumption cycle.

Why do you invest?

You invest for your future well-being and to meet future financial requirements. Anticipated future cash outflows may be in different ways like: children’s education, children’s marriage, buying a home to retire in, etc. There can also be unanticipated cash outflows like: critical disease, accident, natural calamity etc. Thus, investments are made to protect the family against all these anticipated and unexpected cash outflows. The funds for investment comes from assets already owned or borrowed money or savings.

How do you invest?

If you make an investment decision today that will directly affect your future wealth, it would make sense that you make a plan to guide your decisions. Surprisingly, the majority of people do not have in place any type of formalized investment plan. Taking some time to put together an investment plan can reap tremendous benefits. You must have a strategy for your investments backed by a sound reason for investing.

Where do you invest?

Investment can be made into different financial and non-financial asset classes. Financial asset class includes paper assets like:

• Equity shares
• Mutual funds
• Bonds
• Cash equivalent, such as gold, or other precious metals

And the non-financial asset class includes investments in:

• Land and buildings
• Plant and machinery
• Business

And finally, “Be an investor, not a speculator!”…

Investors are defined as: Individuals who purchase assets for the conservation of wealth and the increase of wealth, with the emphasis on the conservation of wealth.

There is another breed of people, speculators, often mistaken as investors. Let us understand speculators - They are individuals who purchase assets for the conservation of wealth and the increase of wealth, with the emphasis on the increase of wealth.

In simple words, ‘Investment is safe speculation and speculation is hazardous investment’. There is a saying in equity markets that, “Those individuals, who invest, make money for themselves and those who speculate make money for their brokers.”

Priyesh Shah is Chief Financial Planner, working with SRE Financial Planners.

Tax is the most terrifying word for one who needs to pay it. There are many provisions in the IT act by which you can plan and minimize your taxes. One of the provisions through which one can reduce tax liability is by taking deductible from gross income to the maximum limit of Rs.100000 under Section 80C of the Income Tax Act. This can done by investing into life insurance policies, PPF, equity-linked saving schemes etc.

So where to invest to get deduction under Section 80C?

Let’s look at some basics and then we would be in a position to compare them:

An Endowment Policy is a traditional policy which has a risk cover policy for a specified period. At the end of the policy tenure the maturity benefit is paid off. The maturity benefit in this regards is the sum assured and the bonus accumulated during the term of the policy.

A term policy as the name suggests covers the risk for the particular term selected. It is the cheapest of all the life insurance policy, as it is the purest form of insurance the premium collected will not include any investment element in to it.

Public provident fund (PPF) there is a lock in period of 15 years with a minimum amount of Rs.500 and maximum of Rs.70,000 to be invested every year. PPF earns 8.00% p.a.

Equity linked savings schemes (ELSS) are basically a tax saving tool; which safeguards an investor from the short term volatility of the market. As it has a lock–in–period of 3 years. It is a high risk, high return investment. The asset allocation of an ELSS would ideally be 90–98% equity exposure and the balance may be in money market or government security. This makes an.

In an endowment policy the liquidity is blocked for the tenure of the policy and you miss out on the opportunity of booming economic conditions. One more negative which is associated with the endowment policy is that the bonus which is declared in the financial year is not compounded and investor is paid only the actual amount of bonus received in the subsequent financial year at the time of maturity. In case you surrender your policy you get a surrender value after paying a certain surrender charges for it.

On the other hand if you purchase a term policy along with a PPF or a term policy along with ELSS you will get a better return on your investment as compared to an endowment policy.

Let us understand with an example. If you take an endowment policy with a sum assured of say Rs.10 lakhs for tenure of 20 years. The annual premium payable would be Rs.47,000. If you buy a simple term life insurance policy for the same sum assured i.e. Rs.10 lakhs for 20 years the annual premium payable would be Rs.2920. The balance of the premium i.e.Rs.44,080 (47,000 - 2920) if invested yearly in PPF for 20 years at 8%p.a. the accumulated amount would be Rs.20,17,187. In other case if you invest the difference of the premium i.e. Rs.44,080 on a yearly basis in ELSS which gives you a compounded annualized growth rate of 12.00% p.a. the accumulated amount would be Rs.31,76,072.

A risk-averse investor should look in for a term insurance along with a PPF option. A risk-liking investor should look in for a term insurance along with an ELSS option since ELSS is more aggressive - its inclination is mainly into equity investments which yield better returns in a longer tenure, beating inflation.

Unit Linked Insurance Products popularly known as ULIPs are the most selling product in the Insurance market. Almost half of the Indian public invests in to ULIPs. They sell like hot cakes in the Indian markets with their promise of giving market linked returns combined with the benefits of insuring your life in case of any unforeseen events.

To describe ULIPs further, they have four or more types of funds they invest into. The investor has an option to invest into which ever fund he wants to invest into. This depends completely on his risk taking ability and time horizon of investments. The most risk taking individual can opt for an option which allows him to take 100 per cent exposure into the equities market, where as the most risk averse investor also has an option of putting the entire amount into the safer instruments. The key issue over here is to match the right asset allocation to the right risk taking ability in accordance with the time horizon of investment.

Along with this feature of ULIPs, you also get an option of switching in between funds. Generally you gets four to six free switches per annum. After you exhaust the free switches you have to pay per switches. Say you chose a fund with 100 per cent allocation towards equities. You have been invested into this fund for almost a year now with the equity markets performing amazingly well. Now you think you have made enough and you think you prefer shifting a part or whole of your corpus towards a less risky portfolio. You have an option in ULIPs where you can choose to move your portfolio into 60 per cent of equities and 40 per cent of debt.

Does the above give you an impression that I am asking you to time the markets? No, because I am a firm believer that no one can perfectly time the markets. The strategy to be applied here is to do a goal planning in which you state that this year you want a return of say 20 per cent per annum. Now as soon as your portfolio in to equities shows a return of 20 per cent even if it is only two months from the date of investment, you should shift at least 50 per cent of your portfolio into debt instruments by using your switch options.

For deciding when to switch, you should keep the following in mind:

• Goal Planning: The entire process is how you manage your finances depends on the goals you have in your life in terms of money needed for the same and what rate of return you have to get to achieve your goals. If you have already collected enough money to reach your goals then you should switch your money in to less riskier options.

• Asset Allocation: This is probably the most important thing to be kept in mind when you plan your finances for the future. The key is to get the expected returns by striking the right asset allocation and diversifying your portfolio. Any time your desired asset allocation changes by huge margins, you should use your switch options to match it over again.

• Risk Appetite: The process of goal planning and asset allocation depends on the risk appetite you have. You should always try to analyze how much risk you can afford to take. In case your risk appetite says an asset allocation of 80 per cent in equities and 20 per cent in debt, then you should never invest in to 100 per cent equity fund. You should switch as soon as your equity portfolio grows out of proportion in comparison to the debt part.

• Time Horizon: Time horizon is very important. The closer you get towards reaching you goal you should keep moving your portfolio in to safer options rather than too much of equities.

Abhishek Kumar Singh is a Certified Financial Planner working at ApnaPaisa Services Pvt. Limited.

Agent: Sir this is the best plan for you - it will give you good returns as well as proper risk cover. The premium is also cheap, just Rs. 35000/- p.a. The insurance cover is Rs.5 lakhs. After every five years, you will get 20% of this insurance cover back. At the end of the 20th year you get the remaining 40% of insurance cover with all accumulated bonus. As you are just 28 years old, this plan is well suited for you.

Client: OK. I know this plan very well. Another agent had explained this plan to me. When I asked him how much premium he was willing to pay on my behalf, he said he could pay 2 months’ premium. If you can pay more than that, I will purchase this plan from you.

Agent: No problem, sir! I want to complete my sales target for this year; I can pay 3 months’ premium for you. You should know that I am paying more than the commission I am receiving.

The sale is made.

…This is the Indian financial market…

Nobody is bothered about:

• Financial needs analysis
• Risk measurement and management
• Rate of return from investment
• Capital appreciation

The effect:

• Mismatched asset allocation
• Huge uncovered risk
• Poor rate of return
• Capital eradication due to inflation
• Non-achievement of financial goals

Who is responsible for this? The part-time agent, who sells the products without any financial knowledge and just wants to complete his/her sale target? Or the buyer who is just concerned about the illegal premium rebate?

The agent paying the premium amount on the buyer’s behalf is very much like a bribe received for purchasing a product. For small gains in the short term, the buyer is actually opting for huge losses in the long term - losses that are not quantifiable at the time of sale.

Why does this happen? Here are some reasons that might give you a clue:

• Competition among agents and financial organizations
• Lack of a professional approach to financial planning
• Perception of financial consultancies as a part-time profession
• Lack of innovative financial products from financial organizations
• Lack of selling and communication skills
• Lack of trust and confidence in the customer’s mind about their financial planner
• Lack of back-up for the so-called financial planners – no proper knowledge, proper office with staff, no technological assistance
• Low standard of entry into financial consultancy – HSC pass plus a few elementary examinations is all that is required to start off as a financial consultancy
• Huge market requiring huge number of financial planners, resulting in financial organizations recruiting any half-decent Johnny as a financial planner

Rebates in the Times of Nationalization
Before 2000, financial sectors like insurance and banking were nationalized. Public sector organizations never bothered about their agents’ knowledge and skills or how they were procuring the business. They didn’t need to as there was no competition. The only competition was among the agents to grab maximum business. This would result in them offering part of their own commission to the buyer as rebates. They were also known to offer some extra incentives in cash or kind to complete a sale. These practices continue to this day.

Although these offers are unethical and illegal, they nevertheless took deep roots in the insurance fraternity. As a result, the customer began to consider a premium rebate in the light of his/her right. He/she did not have any qualms in accepting a rebate or a gift.

Rebates in the Open Market
As the market was thrown open after 2000, various private companies entered the fray increasing customer awareness about maintaining their financial health.

They offered various new products and public sector players were forced to increases their product portfolio as well as services.

With this influx of new companies and products, insurers needed staff to sell them to the public. Enter fresh graduates, call centre executives and banking employees, who started selling financial products with the same elementary knowledge and wrong information as their predecessors in the public sector entities. Result? The rebating habit caught hold here too.

Rebates vs. Discounts
For selling any tangible product, sellers offer discounts. Discounting is used as marketing tool to attract the consumer. Consumers are offered some schemes or free gifts for buying particular products during particular time-periods. Sellers use stock clearance sales as a tool for moving dated products from their stores.
But, in no case do they ever sell a product below its cost. They always try to manage the pre-decided profit margin while selling such products - i.e., they reduce their profit margin to the bare minimum by reducing the sale price.

Generally, prices are first increased and then reduced by giving discounts, giving the customer the feeling that he/she is winning the bargain battle. And this feeling urges the customer to buy more, thus increasing sales.

Discounts are ultimately healthy for the customer because even with the discount, he/she receives the benefit of the product without losing the quality of the product as a result of the discount.

But the same strategy cannot applicable to intangible financial products or services.

Benefits in the case of financial products come in the future and they depends on external factors such as the world economy and market conditions. Regular reviews and proper follow-ups are necessary for a financial product to achieve the desired benefits or goals. The impact of wrong financial decisions can be verified only in the future, by which time they are irreversible.

Purchasing financial products is like cultivating a farm. Timely water, fertilizers, pesticides, and insecticides are necessary for the farm to thrive. It requires years of such care to bear fruit, literally.

Ditto with financial products. They are not one-time affairs. It requires nurturing and caring for decades, regular review of your financial position, changing plans according to changing needs, and regular follow-up to ensure the product’s success.

When a customer demands a rebate he/she is risking not getting future follow-ups, regular reviews, and proper attention to maintaining his/her financial health. In other words, discounted service always leads to discounted quality. If any financial consultant agrees to provide service on rebate, the customers must think twice before taking the consultant’s advice and doing business with him/her. Why is the consultant doing this? Is he/she a proper knowledgeable person in the finance field? What is his/her experience? Will he/she be available for providing follow-ups and after-sales service? Does he/she just want to complete his/her sales target? Ultimately, is this sale transaction going to be a one-time affair or an instance of life-time parenting?

Demand for Rebates – Call for Losses
Customers demand for rebates due to two reasons:

• They are totally ignorant about their financial requirements and do not know about the financial consultant’s ability to change their financial health by proper service and advice. Customers then buy into the regular short-sighted practice of demanding rebates.
• Customers might think that they are fully knowledgeable in the field of the finance and thus do not require any advice or service any time in future. Their main concern at the moment might be that they do not have the right channel to buy financial products without interference from intermediaries such as brokers. Buying financial products from financial consultants is an easy way out, especially with the promise of rebates.

I would like to ask just one question to both of the above-mentioned types of customers: Would you dare to ask a rebate from your doctor for his services? How reassured would you then be that he/she is giving you the absolutely best quality attention to your medical problems?

To maintain good financial health, take the best of the best services from professional financial planners and avoid all agents or so-called financial planners whose interest in this profession is at best half-hearted.

Quality always comes with a price, even if the quality is not visible to the naked eye. Remember, brass and gold don’t have same price.

Key Qualities of a Financial Planner - Knowledge and Integrity
A financial planner needs to assess customers’ present positions, prioritize their needs and goals as per their risk appetites, and then suggest the proper financial product (s) that will fulfill those goals.

This requires proper knowledge of various faculties of finance like insurance planning, risk management, retirement planning, investment planning, portfolio management, estate planning, plus various laws such as the Income Tax Act, Gratuity Act, Companies Act etc., and so on. Armed with this knowledge, the planner now needs to compare the various products on the market, weigh the pros and cons of each, and then suggest the suitable product to the customers.

Another quality is integrity. Integrity to the customer as well as to the organization that he/she represents. This quality is the basic need to develop the finance industry in India today.

When financial planners are ready to offer rebates, it means that they are ready to adjust their integrity. It also means that they have no qualms in suppressing or misrepresenting valuable information to earn extra commission. You have the right to always expect the highest level of integrity from your financial planner - he or she is, after all, the trustee and caretaker of your finances and your guru in all matters financial.