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August 27, 2018

Mutual funds: Achieve financial independence with prudent planning

As our country celebrates the 72nd year of independence, investors should look forward to financial independence, asthe economy gathers its pace of growth. It has become imperative for Indian investors to secure financialindependence, as the society gives way to nuclear families amid rising life expectancy and cost of living.

 

Investors should focus on the below to achieve financial freedom.

 

Risk mitigation: An investor should mitigate risks from various exigencies, such as sudden hospitalisation, demise of the breadwinner or a job loss.Even a well-planned financial plan can go for a toss due to such risks. Hence, it is imperative to secure with insurance (mediclaim and term insurance) and contingency fund.

 

Risk profile: An investor should understand his/her own risk profile well before drawing up a financial plan. Despite a higher proportion of youngpopulation in the country, the investment pattern of households shows that the majority still prefer physical assets and valuables (58%)1. Even infinancial savings, the major pie belongs to banks’ fixed deposits (62%) and only 10% of it is invested in capital market products (shares, mutual fundsand debentures). As young investors have the benefit of time (age), they can make good use of the power of compounding, by investing in equity on a long-term basis. Consider this. Equity (represented by S&P BSE Sensex) has given on an average 14% annualised return2 on a rolling basis for a 20-yearholding period. Mutual funds can be a good platform to invest in equity, as they are professionally managed and a diversified product. Investors whodon’t have higher risk appetite can even explore hybrid and debt oriented mutual funds, which give optimum risk-adjusted returns versus traditionalinvestment products.

 

Act now: Procrastination is a hindrance on the path towards financial independence. For instance, a25-year old investor wants to retire early by the age of 50 and has earmarked a retirement kitty of Rs2 crore. He/she can achieve this dream by starting a monthly systematic investment plan (SIP) of Rs7,400 for the next 25 years (refer chart). However, if the investor delays starting the investments forthree years (at the age of 28 years), his/her monthly investments would rise to Rs 11,450. A delay offive years (at the age of 30 years) would double the monthly investment to Rs 15,400.

 

Augmenting investments: To achieve financial independence sooner, an investor should increase theinvestments over time. It is prudent for the investor to increase investments a long with rising income. Let us consider a couple of scenarios: (A) the investor invests Rs 1 lakh annually but doesnot increase his investments; and (B) the investor increases investments by 10% annually. The resultis, by increasing investments by 10% per annum, the investor will beable to garner Rs 11 lakh more (refer table).

 

Smart features of mutual funds: The SIP feature of mutual funds iswidely adopted among investors, thanks to benefits such as costaveraging and disciplined approach. This is evident from the fact that SIP accounts have more than doubled in the past two years to March2018, crossing the 2-crore mark3. However, investors can also makethe best use of other features of mutual funds for attaining financialindependence.