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Part one of Zero to Investing series : for absolute beginners starting out with investing
You're at level zero, if you've basic idea about bank accounts, or maybe some idea about FD, have heard about SIP stuff, and that is it.
Otherwise, we'd assume you're a well-earning professional, protected by parents. Who are also likely to not have great ideas about money management.
These are some common ideas you probably hold dear
- Buy your house first
- Real estate is the best investment
- FDs are the best, even better if you invest in FD in your spouse's name ,to save tax
- Gold is the best hedge against inflation, it always goes up
Let’s start with the most basic question.
Why do you earn money?
Why have you studied so much (12+3+2 or 12+4+/-2, we have added MBA level to a graduate or engineering graduate). Even longer, if you're in medicine.
In short, 17-18 years of studies. Plus add 2/3 years of working. And yet, there are not equal minutes to have really read and understand how to manage all that money that has been earned and will be earned in the future.
We earn money as professionals, because that is what our parents / peers / society etc. have trained us to do.
That is what has been passively shaped by everyone around us, but not by us internally. Our environment gives us ideas about how to get a good earning career, or how to have a good CV to get into a good company, how to shape our personality, etc.
And then how to save or invest, etc. Everything passive, bombarded by messages from all around us. The result is, if someone asks us anything about it, we even feel proud that we don’t know anything about money management.
Since we don’t know anything about it, and when we are starting to dip our toes in this ocean of information about money management, it's scary.
It turns into an analysis paralysis - since I don’t know what to do, I'll do nothing.
Some will keep kicking the can down the road, without taking any money management decisions themselves. Some would do what their bank RM or LIC uncle tell them to do. Most would continue to find topic of money quite boring and mundane, something they'd prefer never have to deal with.
If you want to buy things you want, you have to save.
This was our first lesson in savings and investment.
We'll be writing about someone who has got some amount but don’t know how to start managing it. Rather than someone who is about to start.
Bank Account: The earned amount is sitting in the savings account and earning a measly 3%-3.5% (tax free up to 10-15,000 – whatever govt has limited, as such the amount is small). This money is relatively safe. Relatively, because in today’s world of online banking and debit cards, the risk is non-zero.
So where to start?
Let us first understand some basics:
Savings Options are FD/RD (Fixed Deposit / Recurring Deposit), NSC (National Savings Certificate), PPF (Public Provident Fund), private companies FD (like Shriram finance, Bajaj Finance, and others) and mutual funds categories which deal with bonds (also known as debt papers).
All these are called Debt instruments. Basically, you give your money (called principal amount) to the other party (govt, bank, private company), and they promise to give a certain percentage of returns over and above the principal amount. So, you give them P (principal) and then give back P + I (principal and interest) after a period of time.
An example of FD: you give the bank 10,000 today. And the bank promises to give you 10,000 and 7% (700) after 1 year.
An example of RD: you give the bank 1,000 every month, and the bank promises to give you 12,000 (1,000 x 12 months) and around 400 additionally as interest. This is back of the envelop calculation.
Moreover, you have to pay income tax on those 700 and 400 rs. Just try to understand how difficult it is to earn money on the savings amounts and which when subjected to tax, comes out to how little. In this case, if you are in 30% bracket, then you are getting only 490 and 280 rs finally, after you have saved that amount of money for 1 year.
The corollary is since you have not been investing at all, you are not even getting that amount till now. Not even those measly 490 and 280 even all these years.
I will cut short the other options, because they are as pathetic for someone of your condition.
The “best” option right now to move that money out of the rut is to put majority of money into a liquid mutual fund.
Why that thing? Because they are:
- Diversified Basically, Liquid MFs keep money into a large number of different areas, so that if one area goes bad (recent news like IL&FS, or CoVid crash), then your entire corpus is not in jeopardy all at once. The more diversified the money is kept, better is the protection (this is a general rule, but there are exceptions, which we'd get to later).
- In general, you can earn more than FD, both as amount of interest as well as with less tax, if you keep the money in there for >3 years.
- Third and most important, the money withdrawal is flexible. You want to redeem only 5,000 INR, you can. You want to take out 1L, you can (of course, you should have more than 1 lakh invested). You want to remove the entire amount and see it in your balance, you can do that as well
You will receive money only the next working day from liquid mutual fund. For smaller amounts, (<50,000 INR, or 90% of your investments, whichever is smaller), most liquid MFs have the facility of 24x7 instant redemption via IMPS, which is a great thing.
Solution: so, for that person with 24L, we advised him to keep 3L in savings account (he had been seeing that huge amount in his account statement, so just could not ask him to remove everything. It would have been a shock to him), keep three 1L FDs of similar maturity and rest 18L in ICICI Prudential liquid fund.
We're giving a specific name here, because there are so many options in that category, that it again causes action paralysis of which one to choose.
Other one which we can recommend is Parag Parikh liquid fund (because they have put most of their portfolio, mostly in the SOV-rated RBI papers; which if you don't know what is, know that it's the safest piece of debt instruments out there).
From other analysis available on the internet, Quantum’s liquid fund is a good idea.