Stock Market Series I – 7 Thumb Rules of Investing for Beginners
#how to invest
20th Dec, 2012
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We work so hard for our money and accordingly we also want our money to work equally hard for us. The idea behind investing is to put the money to use in such a way that it generates more money for us.
How to Invest?
We all should invest with a purpose in mind. As it is rightly said, when a purpose of a thing is not defined, abuse is inevitable.
Hence the first step of investing is formulate some investment goals- New car, home, retirement, education, tax saving, vacation and so on. Then assess how much would you need and how long are you willing to wait in order to accomplish your goals and how much are you willing to risk to realize your goals. Hence based on you time frame as well as you willingness and ability to take risk; you need to select the investment option. And accordingly based on the return expectation of the investment avenues you chose, you need to calculate how much you need to invest today (lump sum) or every month to achieve your goal.
7 Thumb Rules of Investing:
The financial markets offers numerous opportunities for investor to invest, there are some commandments of investment that every investor should follow, no matter whether he is savvy or a novice.
1) Start early: As is rightly said by Albert Einstein, “Compound interest is the eighth wonder of the world. He who understands it, earns it…he who doesn’t, pays it.” The sooner you invest, the more time your money will have to grow. If you delay, you will almost certainly have to invest much more to achieve a similar result.
2) Invest regularly: Invest regularly can be great way to build up a significant wealth over long term. You will also benefit by rupee cost averaging, buy more units when prices are low and buy less units when prices are high and bringing down the overall cost.
3) Keep some cash aside: It is always a good idea to create a contingency fund which can be used in case of emergencies. It is recommended that contingency fund should cover at least 3 to 6 months of your living expenses as well as your monetary liabilities (EMI). The contingency fund should be invested in such an instrument that allows you to withdraw the same without any penalty.
4) Understand how much risk you can take: All five fingers are not same, similarly all individuals are different. It is vital that you access your own appetite and ability to take risk before selecting any instrument. Hence it is recommended that do not just invest in instrument that your neighbours or friends have done, do your own due diligence before investing.
5) Investment should beat inflation: Returns from risk free investment may sound respectable, but if you subtract the same with inflation it may not impress you. For significant long term wealth creation, you have to make sure your money works harder for you. Hence you need to invest in instrument that gives you better positive inflation adjusted return (a.k.a. real return). For instance in the last 3 years, the average inflation rate has been around 9% and if we invested in any instrument which has given below 9% post tax return, then our real return has been negative.
6) Spread your money across investment products: As it is said, do not put all your eggs in same basket, the same applies for your investments. Depending upon your goal, time horizon, risk appetite, you should spread your money across different types of investment like Equity, Debt, Gold, Cash, and others.
7) Review your investments: A portfolio that is right for you at one point in your life may not be quite so suitable a few years later. The investment need to adapt changes as per the change in circumstances in one life such as new job, getting married, having children, starting a new business etc. Investor should also review their funds in the portfolio to see if they are working as per the expectation. The ideal thumb rule is a quarterly / half-yearly review depending on the complexity of the portfolio.
Every investor must begin somewhere. Before investing money to any investment options, they first need to set goals, understand some basic investment rules, and the most important thing to realize that investing is not intended to be an overnight get-rich-quick success.
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