Investing for the first time? There are a number of questions one must ask oneself before starting investment and building a portfolio. Wealth creation is a long-term exercise and continuous planning is involved to achieve one's financial goals. The first thing to keep in mind is not to put all eggs in one basket which is why asset allocation becomes very important while investing.
Where can one invest?
New-time investors must know all the options they have before investing. Some basic investment options include stocks via mutual funds or direct trading, bonds, gold, real estate, fixed deposits, government schemes like PPF, among others.
How long do you have to invest?
This is the second question one must answer. In terms of asset allocation, this is a very important point and will vary as per your age. Where to invest will differ and depend greatly on if you are 25 or 50.
Suppose you are investing for retirement, when you are in your 20s, you likely have 40 years to invest before you need that money back, and hence can choose aggressive or high-risk investments that have high growth potential. But if you are in your 50s, and only have 10 years before retirement, more moderate or conservative investment options are a better bet. In this scenario, say if the stock markets have a bad year, you will have less time to recuperate from the losses. So, you are more likely to choose investments that give decent returns but are less risky.
How to determine where to invest as per age?
There’s a common formula for asset allocation as per age.
100 – age = percentage
So if you’re 21, you would invest 79 percent in stocks and 21 percent in bonds or other less risky investments like gold. If you’re 60, you would invest 40 percent in stocks and 60 percent in bonds and others.
Generally, the equity markets and bonds move in opposite directions, so if you have invested in both bonds and stocks, volatility or losses in one will likely be capped. A combination of asset classes should reduce your portfolio’s sensitivity to market swings.
Why should you not invest only in one asset?
Only investing money in a single asset increases risks of losses. For instance, you invest all your money in stocks and due to some event the stock market crashes, like in 2008 when the global financial crisis hit and stocks, bonds, mutual funds, and real estate all took a nosedive. But with asset allocation, these risks can be minimized and the losses can be trimmed.
Making a portfolio
Suppose you are a new investor, it is important to find a portfolio you are comfortable with and a good distribution between stocks and bonds. For instance, you might buy a bond index fund if the majority of your investment is in stocks.
You should also answer questions like do you want to invest all in direct stock trading or divide with mutual funds. So, how do you decide the best portfolio and approach for yourself? It depends on the goal.
How soon will you need the money?
If you're looking to invest for over 20 years, a higher allocation to stocks can be chosen since you have a longer period to invest your money and give time for markets to rebound in case of a crash. However, if your investment period is less than 10 years, invest in a combination of bonds and stocks since you do not have a longer time to make up in case of a loss. If you need the money in between two and five years, only quality stocks and bonds.
How comfortable would you be with losing a third of your money in a year?
Although rare, the stock market in worst-case scenarios has lost up to 30 percent. If you are comfortable with this kind of loss once you have time to recover, investing in stocks can be rewarding over time. But if this kind of loss will leave you in financial distress, you should consider investing more in bonds and safe-haven instruments like gold which can soften the blow of the stock market’s more volatile ups and downs.
After deciding how much to invest in stocks, the first step is choosing a broker.
If you’re just starting out, you may prioritize features like basic educational resources, good customer care, and fees while looking for an online broker. You should also see the kind of services it offers, does it have an easy and consumer-friendly layout, and must-read its reviews before opening an account.
You should also decide if you want to trade on your own or need a personal manager to help understand and suggest trades. The fees will vary in both these cases and you should be clear on the terms and conditions beforehand.
Another important feature is security. Since your bank account is going to be linked with your broker, it is immensely important that you not compromise on security. The brokerage must have a two-step authentication process and no history of hacking is like a cherry on the top.
It is also advisable to carry out a few play-trades and see if you are comfortable with the portal before carrying out actual trades.
Stocks or Mutual Funds?
If you are just starting out it is advisable to start with mutual funds since they are a group of stocks instead of directly investing in a single stock where the risk of loss is higher. If it is possible for you to invest a small amount over a period rather than investing a large amount at once, a systematic investment plan (SIP) is a good option. You can start with as low as ₹500 per month in a SIP as you slowly start building your portfolio.
As and when you get more comfortable and understand the stock market better, you can slowly move to direct trading in stocks.
How much to spend in a month?
This completely depends on your financial situation. But one must note that you should only spend the amount per month you are k with not having back for a while. Generally, the best thumb rule is 10 percent of your salary should go to savings and from that, you can decide how much you can risk losing (or not having back for a while) and invest that amount only in the beginning. Later this amount can be slowly increased as your portfolio grows.