Q1. I’m a novice when it comes to investing. I hear that funds may be large cap, mid cap, or small cap? What is the difference? How does it affect me?
Let us begin by understanding market capitalization (market cap, for short). It is the total market value of all shares of a company. So, if a company has issued 25 million shares and the price of each share is ₹150, the market capitalization of that company is (25 multiplied by 150) ₹3,750 million or ₹375 crore.
A company is considered large cap when its market cap is equal to or more than ₹20,000 crore; mid cap when it is between ₹5,000 crore and ₹20,000 crore; small cap when it is less than ₹5,000 crore. Deriving from this, a mutual fund is labelled small, mid, or large cap depending on the size of the stocks it focuses on.
It is important for you to diversify your investments. It follows that it is important for you to know if the fund you invest in is small, mid, or large.
Large cap stocks are considered less risky and more stable than mid and small cap stocks. Small cap stocks, on the other hand, are considered the riskiest, but can have good growth prospects over the long term.
So, after considering the fundamental aspects of your financial plan, like your goals, time horizon and risk appetite, you will want to understand the “cap size” to know if it is the right fit for you.
Q2. I am planning to insure my life. How can I estimate the ideal cover for me?
You are right to carefully consider the best life insurance cover for you. It should be small enough for you to afford the premium for now. Yet, it should be substantial enough to take care of your family’s needs when you are no longer around.
The following rules can help you with the estimate.
Your ideal personal cover should be six to eight times your gross annual income. If your gross annual income is ₹10 lakhs, go for a policy that gives you a cover of ₹60 lakhs to ₹80 lakhs.
Your income plus your expenses
The sum insured should be equal to five times your gross annual income plus the total of basic expenses like housing or car loan instalment, debt repayment, child’s education, etc.
Premium as percentage of income
Will you be able to pay the premium comfortably after meeting all your regular expenses? Is the premium payable an affordable percentage of your disposable income?
Family’s needs now and later
Consider your family’s needs after you. Divide those needs into the immediate (cash needs soon after you are no more) and ongoing (income needs for a longer period). The amount of insurance should cover both the immediate and the ongoing needs of the family.
Q3. Some time ago, I had paid fees to my financial planner for preparing a plan linking my goals to my investments. Now I have been asked to review my plan, which means I must pay some fees again. Is a review necessary?
A financial planner understands your life goals, assesses your financial situation and your capacity to take risks. The outcome is a plan that is tailored to you. As all those factors change over time, it is important to repeat the exercise during a review to assess the changes in your life goals and to ensure you are still on track to meet those.
Here is how a timely review can help you.
Helps adjust to changes in income, lifestyle
Over a period, you may earn a well-deserved promotion or move to a better-paying job, perhaps in a different location. The economic impact of a war in a faraway country can increase global inflation which can slash your investible surplus. You may start a family and will have to start planning for the child’s future. A senior member of the family may fall ill requiring lifelong support and care. When you chalked out the initial plan, neither you nor your financial planner could have anticipated these changes. Therefore, it is imperative that you take a fresh look by opting for a review.
Helps change investment strategy to match goals trajectory
Setting goals is not enough; you must track how close you are to achieving those. Depending on your personal circumstances and the changes in the economy, it may be necessary to delay or adjust some goals. You may even achieve some goals sooner than the timeframe you had anticipated. A review helps you account for these and make prudent use of your earmarked funds. For example, if you have attained the target of buying a car, you could use the money that is released to enhance your retirement fund or your child’s education fund.
Helps portfolio stay on track and check market risk
As your planner might have told you, depending on the market conditions, the equity-debt balance in your portfolio would need a readjustment after every 12 to 18 months. If you do not review your investment status, you may veer off the path to your goal or, worse, you may expose yourself to the risk of losing whatever progress you might have to adverse market conditions. A review can warn you in advance and protect your interests.
Helps secure and preserve benefits of equity growth
When the market is bullish, the equity part of the portfolio would grow bigger than the debt portion. When you review and rebalance, you can shift the equity gains to debts and thus secure the profits. For example, let us assume your original allocation for investment between debts and equity was 50:50. During a year, equity grew by 20% and debt by 10%, thus creating a gap in the allocation. You will need to move some funds to debt to retain the original allocation ratio and, in this process, you will also secure the gains you have made from equity.
Helps eliminate or replace investments gone bad
Every investment is made based on past performance and a judicious analysis. However, some investments may not perform well because of various factors not necessarily related to the specific fund. A review in time can save you from substantial loss by facilitating an early shift to another avenue. It is important to rely more on what the performance figures tell than on assumed reputation and optimistic projections.
Q4. What is the savings rate? How can savings rate affect my timeline to attain financial independence?
You know that the excess of your income over your expenses forms your savings. Divide that savings figure by your income and you get your savings rate. If you are earning 1000 and you spend 850, you save 150 and your savings rate would be (150/1000) 15%.
However, it is not enough to just save. You must invest wisely for the magic of compounding to start multiplying your money. Your invested money becomes your partner in generating money—a partner who continues to work and earn for you even when you sleep.
Make it a habit to save before you spend, invest your savings right and periodically review and refine your investment strategy. You could well be on your way to an early retirement.
But it all starts with your savings rate, which makes it the best predictor of your financial strategy and your timeline to attain financial independence.
International Money Matters Pvt Ltd is a SEBI registered investment advisory firm. If you have any personal finance queries, click here to talk to advisors from IMMPL.
Note: This story is for informational purposes. Please speak to a financial advisor for detailed solutions to your questions.