Simple adjustments to your personal finance habits can lead to big improvements in the yields of your investments. Here are four tips to optimise your personal finances.
ELSS SIP: Every year, around December/January, I often get calls from friends and family asking me for advice on ‘tax savings’. This is because their employers would have demanded a proof of ‘tax saving investments’, for claiming deductions under Section 80C. Failing to produce the necessary proof would result in deeper tax cuts from the salary. Most people don’t plan in advance and find themselves in a messy financial situation by the end of the fiscal year. Planning this at the beginning of the fiscal year would be prudent. Estimate how much you need to save to enjoy the tax exemptions under Section 80C; then divide that money into 12 parts, and invest that in an ‘Equity Linked Savings Scheme’ (ELSS) fund on a monthly basis.
For example, if you estimate to save Rs. 1,50,000/- for the year, then invest Rs. 12,500/- every month in an ELSS fund. Investing the same amount every month is called as a ‘Systematic Investment Plan’ or SIP in short.
Investment in an ELSS scheme comes with many benefits.
- Investments up to Rs. 1,50,000/- per year, in any ELSS funds, are exempt from income tax.
- The funds are invested in equity, arguably the best asset class to invest in. Historically, investments in equities have yielded returns of around 13%.
- Since you would be opting for an SIP, you invest smaller amounts every month. This is easier on your wallet, and you benefit from spreading your investments across the highs and lows of the market.
Rethink Insurance: Insurance is often the most misunderstood and mis-sold financial product in India. Insurance agents peddle insurance usually linked with endowment plans that generally give mediocre returns. Now, because of the investment component, these insurance plans make you believe that you are actually saving money while paying for insurance.
Insurance is an expense. It cannot substitute an investment, whichever way you look at it. To complicate matters, some insurance plans come with an annuity component; wherein a future cash flow is expected. If you actually break down the numbers, you will realise that the rate of return on these instruments is mediocre, sub 7%, in most of the cases. There are two serious problems with such ‘investments’.
You commit large amounts of money every year (for many years) towards such low yielding avenues. You lose out on attractive investment opportunities, which could have generated great returns. The aim should be to avoid such follies.
Insurance is a necessity; treat it as an expense and pay for it. You need
- A term plan that will cover your family against all the liabilities, in the case of your unfortunate demise;
- A medical insurance to cover you or your family for any hospitalisation costs.
Keep it as simple as that. Do not over complicate insurance.
Index ETFs: People find it hard to devote time to identifying investment ideas in direct equities. Such individuals should consider investing in an ‘Index Exchange Traded Funds’ (ETFs). By definition, an ETF replicates the returns of its respective underlying. For example, an Index ETF like Nifty Bees mimics the performance of the Nifty 50 index. One should consider an exposure towards an Index ETF. The rationale is very simple; an index like Nifty 50 represents the broad Indian economy. If you believe the Indian economy will perform well going forward (I do), the index will also do well. If the index performs well, so will its ETF, which means your investment in that ETF will do well.
Educate yourself: Knowledge empowers you to make intelligent decisions. In the case of personal finance, this leads to better returns. Packaged investment products such as mutual funds and ETFs are a great way to build wealth. However, none of them can beat the returns generated by investments in direct equity. Of course, investments in direct equity also carry a higher degree of risk. That said, you can mitigate this risk by being on top of the game. Look for stocks worth investing in and learn how to red flag companies not worthy of investments. Learn how to manage your investments. Thanks to the internet, a lot of high-quality finance content is now available online, for free. Varsity, an initiative by Zerodha, is an excellent resource for investors.