“The rich build multiple income streams to diversify their income.” – Warren Buffet
This is one of the most famous quotes by Warren Buffet, an American business magnate and investor, which stands the test of time. When it comes to investing, the fundamental mistake that most people make is not creating a budget for themselves at the start of the month—a big mistake.
Based on your monthly income, you should clearly mark necessary expenses and allot a certain percentage to your “savings." At no cost should these savings go into a risk-free deposit with the bank. Rather, they should go into a meticulously designed portfolio to create multiple streams of income. In this article, we will look at the top-6 tips to remember when trying to boost your savings via investment management.
Top 6 Investment Tips for Better Returns
Tip 1: Classify Your Funds Right
Classify your funds between an emergency fund (to tide through a rainy day, should it come to that) and a diversified portfolio, where allocations are made to different asset classes based on your ‘risk appetite’ – a concept that depends on your age, liabilities, risk averseness, etc. For instance, a 30-year-old salaried individual should be splitting their savings between 30% of the debt (think: bonds, debentures, deposits, 401Ks) and 70% of riskier assets (think: stocks, mutual funds, REITs, ETFs) to create a portfolio that would serve well to create a corpus to live off of post-retirement.
Tip 2: Connect with a Seasoned Portfolio Manager
A portfolio manager will tell you not to simply follow news and tips that you receive from your friends/co-workers but to invest your funds into various sectors and segments of the economy, such as banks, insurance, pharmaceuticals, metals, FMCGs, IT, energy, to name a few. This protects your portfolio from shocks such as events that negatively impact one sector of the economy but could boost other sectors. For instance, during the COVID-19 pandemic, the insurance and bank stocks tanked, due to greater insurance claims and higher defaults on loans. On the other hand, sectors such as pharma, IT, and FMCGs were booming due to people working from home. Once the lockdowns were done and dusted, we saw the exact opposite. In simpler words, it is essential to diversify with expert advice from your portfolio manager.
Tip 3: Diversify Your Funds: The Golden Rule of Investment
The best way to diversify your investments is by investing in stocks and bonds through ETFs and mutual funds. In fact, experienced fund managers invest funds into a diversified pool of stocks and bonds to protect against sector biases and constantly keep updating their investments.
Pro tip: A great way to enter the market is by starting a SIP into a mutual fund. You start by contributing small amounts every month to buy more units. As the market falls, you get more units for the same amount, thus giving you an edge even when the market is dominated by bears.
Tip 4: Keep the 'Age' Factor in Mind
As you get older, more and more funds in your portfolio will need to move into safer allocations. As a result, the allocation to bonds and debt should increase as these are more stable and provide regular income in the form of interest. Remember that equity markets can be subject to several risks as opposed to say a bond that provides regular coupon payments, or perhaps risk-free deposits with the government that provides a fixed rate of interest and the value is guaranteed by the government.
Tip 5: Consider the Asset 'Liquidity'
Another important consideration while investing is liquidity. An asset is more liquid if it is easily convertible into cash. Thus assets such as stocks and bonds are considered more liquid as an open market exists where these assets can be sold. For example, consider stock and bond exchanges, where a number of buyers and sellers exist enabling investors to immediately sell.
By contrast, other assets such as real estate and unlisted private shares can be illiquid and may take a long time for investors to convert them to cash. Plus, they require third parties such as brokers and dealers to enable a sale, which might be an issue when one needs funds in an emergency.
Pro tip: One way to avoid this is to invest in Real Estate Investment Trusts (REIT) instead of directly purchasing residential and commercial properties. A REIT is a pool of real estate investments against which securities are issued, making them more liquid as these are easily transferable.
Tip 6: Understand the Difference Between Trading and Investing
An investor will buy assets for a longer period of time. In other words, for a long-term horizon, which is generally more than 3 years. Traders tend to buy or sell stocks for the short term, such as for a day or two. Most experienced traders buy or sell stocks on the same day to capitalize on movements during the day. They also use Futures and Options to create value, which increases risk and should only be done by experienced traders and not by new entrants into the market.
Tying It All Together
“The big money is not in the buying or selling, but in the waiting.”
In the end, you need to ensure multiple sources of income. This is why investment is key. Plus, remember that investments should be made based on your risk appetite. Additionally, you should ensure that some of your funds are in highly-liquid assets to help in case of emergencies.
While it’s essential to create value by making investments in other asset classes and not just in risk-free deposits, the best way to tackle the uncertainties in the finance world is by leveraging the services of an experienced portfolio manager to help manage your funds. This is where we at Central Financial Group can help.