Finding investments that are right for you depends upon your personality and your financial objectives. Some people want income now, while others are content to wait. You may be more comfortable with conservative investments, while your friends are willing to accept greater risk in the hopes of maximizing their returns. The following chart shows the general types of investments you can make, depending upon whether you want conservative or aggressive investments, long- or short-term growth.
Whatever investment options you select, it's essential that you develop a plan as soon as possible. The ideas that we discuss in this chapter will help you build a perfect portfolio. Start by discussing your investment ideas and goals with your spouse or trusted friends. Then, put together an investment plan that shows how much money you plan to invest each month and where you plan to invest it. Make sure you include what your expected rate of return is for each investment so that you can track your progress.
15 Ways to Achieve Financial Independence
If you are serious about taking charge of your financial future, then get started. You need to do more than decide to take action, you must actually do it. How many times have you decided to go on a diet, but never started? It's time to jump into action and take control of your financial future. Before you begin investing, you need to have the money to invest. Here are 15 steps that will help you get started.
Find out where you are financially. Go through your checkbook and write down where your money went over the past three months (for example, food, entertainment, credit expenses, etc.). How much money did you make and did you have enough to cover all of your expenses? Did you spend more than you made? If you spent less than you made, what did you do with the extra money?
Set financial goals. To be meaningful, a goal must be very specific, with a designated completion date. Start with small, relatively simple financial goals, such as opening a savings account this week. As you become more comfortable in the goal-setting process, move up to intermediate goals, such as making regular monthly deposits into your PPF.
Cut back on expenses. If you are living above your means, figure out a way to cut back. You must figure out how to live on what you make or you will never gain control of your finances. Develop an emergency cut-back list that details how you will initiate each cost cut-back, how much you'll save, and when you will do it.
Emergency funds. Create an emergency fund that is sufficient to cover three to six months of your expenses. Don't touch the money unless it's needed for an emergency. A vacation to Goa doesn't count as an emergency.
Use insurance wisely. The purpose of insurance is to cover you in the event that you suffer a catastrophic loss. You probably can't afford all of the insurance you truly need, so be very selective and get the most you can for what you can afford.
Use compound interest. Understand how compound interest works and use it to get ahead financially. Apply the rule of 72 when you're thinking about interest options. (Divide 72 by the yield you expect to make on a given investment. The result is how long it will take to double your money. For example, if you believe an investment will yield 18 percent annually, then you will double your money in four years [72/18=4 years].)
Avoid unnecessary debt. If, for example, your current car is running but you want a nice new car, yet you don't have the money, wait until you do. If you really don't need a new car, don't buy one.
Buy a home. It is one of the best tax shelters you can get, and unless you are in a depressed area of the country, you should enjoy appreciation on just about any home you buy.
Work the tax laws in your favor. Make sure you learn about every legal deduction you can take.
Plan your estate. Start preparing basic estate planning documents. Learn about wills, living wills, revocable and irrevocable trusts, and durable powers of attorney. Take action to protect your estate now so that in the event of your death, the people you care about are protected.
Learn all you can. Read everything you can about investing. Learn about short-term and long-term investment options so you can decide what is best for you. In the process, determine what your investment temperament is. How much risk can you tolerate?
Watch inflation closely. Do not ignore inflation even if you think it doesn't affect you. Over time, it will catch up with you. Learn how inflation dilutes purchasing power and what you can do to offset it.
Decide how much you need. Figure out how much you'll need to live on when you retire. This is critical, particularly if you plan to retire early.
Write it down. Write down your plan. If you keep the plan in your head, you'll stay in the deciding mode, and you'll never take action to really begin!
The Best Places to Keep Your Savings
By implementing the money-saving strategies introduced in previous chapters, you should now have some money to invest. But if you're still searching for the perfect investment vehicle for your needs, consider some alternatives. Following are some suggestions on where to keep your money, depending on your short-term (less than six months) or long-term (greater than six months) objectives.
Passbook accounts. They are available in all banks, including saving and loan associations. They offer the lowest interest rates of the savings account vehicles. Use them as a last resort. They're okay to meet short-term savings needs.
Interest-bearing checking accounts. These accounts require that you maintain a minimum deposit before they pay interest. Their rates are competitive to passbook accounts and offer the advantage of check-writing.
Certificates of deposit (CDs). When you invest in a CD, you're putting money into a bank for a fixed term and subsequently earn a higher interest than you would in a passbook account. The minimum term is typically six months, so you need to determine whether your objectives are short or long term.
Treasury bills. Treasury bills are what the government uses to borrow money from investors when it can't collect enough from taxes to meet expenses. You buy them directly (for a minimum investment of Rs 10,000) from the government through Federal Reserve banks, which have regional offices throughout the country. There is no fee if you buy bills direct from the government. You can also buy Treasury bills from stock brokers, for a fee. Interest rates fluctuate, so visit the Reserve Bank of India website for the latest figures. Maturity dates vary from three months to a year, so these securities can be used for both short- and long-term savings plans.
Treasury notes. These are strictly used for long-term savings plans; the minimum maturity date is two years. Like treasury bills, they can be purchased through Federal Reserve banks in Rs 5,000 increments
If you need a good full-service broker, here are several tips to help you find one.
1. Get recommendations from friends and associates. What brokers are they using? What do they like and dislike about their brokers?
2. Select firms and brokers who have been in business since at least 10-15 years plus , which assures you that they have gone through three bad markets. You want a firm that has staying power and a solid set of brokerage talent.
3. Conduct telephone interviews with brokers you are considering. Make sure you give them solid information about your financial position and objectives. Do not exaggerate. Good brokers get all kinds of calls just like yours on a daily basis and they're experts at sniffing out cons, so don't waste their time.
4. Take notes when you talk to potential brokers because you'll be comparing what they say to what other brokers on your list say. If you like what you hear, and they are interested in doing business with you, set up a personal interview.
5. During the personal interview, ask for names of satisfied clients they have handled for at least the past two years. If you are denied, you may have uncovered a problem. If a broker has many highly satisfied clients, then at least one of them will be willing to talk to you.
6. Pare your list down to two or three finalists. You've conducted both a telephone and personal interview and you're now ready to make a final selection. A follow-up telephone call may be sufficient to make a final decision. Ask each candidate about their ideas on how you might best work together to achieve your investment goals.
7. Make sure you understand and are comfortable with your broker's commission structure, any annual fees, transactions costs, and any other expenses that you could incur.
8. Find out what ''free" information the brokerage firm will send you, such as research reports, company announcements, annual reports, and Web access details.
9. When you are finished with the interview process, meet with one or more of your trusted associates to review your findings. Use your notes. But keep your choice secret until your associates give their unbiased opinions.
Warning: All brokers, including good ones, can become puppets of their firm. If the brokerage firm wants something sold, it will put pressure on all of its brokers to push the product.
Should You Borrow Money to Invest?
Henry Ford made his fortune on borrowed money, and so can youif you do it right. The question you need to answer is: How much debt can you afford? The simple answer is that you can afford any debt that pays for itself. If you want to invest in rental properties, and you find one where the rental income pays for all related expenses, go for it.
You can afford any debt that you can easily cover out of your personal earnings. If you have a secure job, up to 40 percent of your income can be committed to repayment, including your mortgage, without putting yourself in a cash bind. You're better off restricting yourself to short-term investments just in case you need to come up with some fast cash. If you can establish a credit line with your bank, you'll have more room to play in the market.
You can go into debt on a long-term investment as long as you have liquid assets to back you up. For example, let's say that you buy a piece of land that you intend to subdivide. Shortly after you buy the land on terms, you lose your job. The bank still expects you to make monthly payments. As long as you have stocks and bonds that can be liquidated to get at the money you need, you don't have to worry
The loan of choice for financing investments is a second mortgage, where you pledge your house as collateral. A traditional second mortgage works just like a first: You borrow a fixed amount of money and agree to pay it back in equal monthly installments over a specified time period, which usually is 15 years or less. You can also use a second mortgage to secure a credit line with your bank. Once approved, the bank grants you a credit limit.
In summary, borrowing makes sense if you can do so at a relatively low rate of return and invest the money at a higher rate of return. To determine if you can successfully make that happen, start off with small investments until you are confident you know what you're doing.
Warning: Be extra cautious if you take out a second mortgage. You are about to leverage your home, one of the most important assets in your financial portfolio. If you use the money for a purpose other than what you intended, such as buying a car instead of securities, you'll double your debt.
Check Annual Reports Before Buying Any Stock
When you buy stock in a company, you instantly become a part owner. You may only have one share of stock, or you may have 10,000 shares, but either entitles you to review periodic updates of the company's performance. Public companies publish quarterly and annual financial reports that explain the company's activities, financial position, results from operations, and senior management's philosophy about running the business for this precise purpose. If you are a stockholder, you can develop a sense of where your company is going and most important, determine if you own a solid investment. Because it's your money that's at stake, you should investigate the annual report of any company you are considering, before you buy its stock. Here's what to look for when you review a company's annual report.
Balance sheet. The balance sheet shows the financial shape of the company on the date the report was prepared, which is usually at the end of the company's fiscal year. It shows the value of assets, such as cash and equipment, all liabilities, and stockowners' equity in the company. The balance sheet indicates if the company has financial strength. If it has too much debt (liabilities), then the company could be in financial trouble. Look for companies whose total debt is less than total stockholders' equity.
Income statement. The income statement shows the company's profit or loss over a period of time, usually a month, quarter, or year. The dollar amount of goods and services that the company sold are subtracted from total expenses to arrive at a profit or loss figure. A decent annual report will compare at least two or more years of income and expenses to help you spot trends. Look for growing sales and profits.
Auditor's opinion. Most annual reports include a letter from an outside auditor (CA firm) as a testimonial to the accuracy of the accounting that is reported in the annual report. It is the function of the auditor to check the integrity of the numbers that are reported and to make sure accepted accounting standards were used. If everything is in order, the CPA will make a written statement to that effect in the annual report. Look for any exceptions that they may have identified.
Footnotes. You may find footnotes that offer more detailed explanations to the numbers reported. Look for disclosures of lawsuits, debts, and other problems that aren't reflected in the numbers.
Cash flow statement. Cash is what pays the bills and assures that the company will continue to function on a regular basis. When a company's day-to-day operation can't generate enough cash to pay the bills, there's trouble ahead. Look for positive numbers in the available cash column of the company's cash flow statement. If the numbers are not positive, the company will have problems investing in its future.
Chairman's letter. The chairman of the board writes a short letter that's inserted into the front of most annual reports. It generally describes the highlights and major activities of the company over its fiscal year. It tells you nothing but the positive things that have happened to the company.
Idea: Always remember that the stock market anticipates. When you pay for a share of stock, you're paying a price that's based on what investors know at the time, and can reasonably predict what will happen in the future. For the stock price to rise, prospects for the company have to improve beyond what investors predict. If things get worst, investors will sell off their shares, which will drive the price down until it reaches a new price expectation level. That is how the stock market game is played!
Why You Should Use Dividend Reinvestment Plans
If you're interested in buying stock in a company, but can't meet the minimum investment requirements, or you don't like paying brokerage fees, then buying shares directly from the company may be your answer. Many companies have programs that allow you to buy additional shares by reinvesting your dividends. Called dividend reinvestment plans (DRIPs), these plans let you leave the dividends you earn in a deposit account to buy additional shares of stock.
To participate in the plan, you're required to own one or more shares of stock. Many companies offer direct purchase plans (DPPs), where you can buy your initial shares of stock free of any broker charges. One of the primary advantages of the DRIP arrangement is that it allows you to invest relatively small amounts of money over time into a company that you feel has an outstanding future. DRIPs and DPPs are offered by many of the larger, long-established companies with histories of paying shareholders regular dividends, such as IBM. They are popular with major corporations because they tend to attract loyal, long-term investors. Five additional advantages of DRIPs are summarized as follows:
1. A low-cost way to diversify your portfolio. For example, if you invest Rs 25000 into each of a dozen stocks, where each is in a separate industry, you will have diversified your investment into 12 industries, similar to mutual funds but without the fee.
2. You can sell your shares, easily, and at any time. Different companies charge different sales fees, so check their fee against your broker's fees to make sure you are getting the best deal.
3. Systematic investing reduces your risk over the long term. By participating in the program on a regular basis (monthly, for example), you're spreading your purchases across the market's valleys and peaks as well.
4. Your money will compound at higher-than-average rates. The history of the stock market has been extremely good to consistent investors over the past 50 years. If you are in it for the long term, you should do well.
5. DRIPs are great investment alternativesand learning toolsfor your kids. You can help them get into a DRIP for a minimum amount in a company that they know, such as RIL, and watch their excitement grow as their stock jumps around the BSE/NSE.
Are Mutual Funds an Investor's Best Friend?
If you believe that diversification is essential to your investment plan, and you like the idea of letting a professional investor pick investments for you, then mutual funds could be your answer. Mutual funds have become an extremely popular investment for people who don't have the time to conduct their own investment analysis. When you invest in a mutual fund, you buy shares in a portfolio of securities managed by a professional investment firm. Your rate of return depends upon how well the portfolio of securities is doing at any one time. Some funds specialize in only one type of security or industry, while others invest in a variety of securities to minimize risk. And not all funds invest in stocks. Many specialize in the bond, commodities, and international markets as well.
Today, there are thousands of funds to choose from with vast investment and diversification spectrums, ranging from ultraconservative bond funds to aggressive stock funds that specialize in fast growth companies. Here are four compelling reasons for considering mutual funds:
1. Diversification. When you invest in a fund, your money is riding on a large number of securities instead of just a few, which lessens risk.
2. Low-cost management. Professional management fees typically run around 1 percent of your investment annually.
3. Liquidity. You can sell your mutual funds any time, just like a stock.
4. Flexibility. If you invest in a fund that is part of a "family," you can switch between the different funds in the family as market conditions dictate or as your investment objectives change. Fidelity Investments offers such an option.
Most funds offer the added benefit of allowing you to deposit a certain amount each month into the fund called Systematic Investment Plans (SIPs). By spreading your investment out over time, you develop a consistent investment plan. But how do you weed through the thousands of funds out there to find the winners? Here are the steps you need to take to get started.
Narrow your search. There are more than 8,000 funds to choose from, which makes it humanly impossible to track them all. Pick one that you're comfortable with and start tracking its performance.
Select funds by type. Settle on the type of fund that you are comfortable with (stock, bond, international). In the process, that will help you narrow your search field.
Know your risk level. What risk are you willing to accept in a fund: high, medium, or low? There are aggressive stock growth funds.
that literally bounce all over the board. So if your heart can't stand wild price fluctuations, look at the mild, conservative funds. The risk you are willing to take will help you further narrow your search.
Load or no-load? No-load funds charge no sales points when you acquire the fund. Load funds charge sales points, which are calculated as a percentage of the sale. For example, if you purchased a mutual fund for Rs 10,000 and were charged one sales point (that is, 1 percent) for the transaction, you would pay Rs 100 in commissions. On the surface, no-load funds appear to be the choice because nobody likes to pay commissions. However, be objective in your analysis; it may be worth paying a sales fee to acquire a top-grade fund.
Look for low annual expenses. Expenses that exceed 1.5 percent of a fund's value are considered high. You want to reward the fund manager, but you don't want them to rip you off.
Find qualified fund managers. All funds are run by a fund manager, not by computers. The qualifications and subsequent performance of the fund manager can literally make or break a fund's performance. Stick with fund managers who have been managing mutual funds for at least five years and who have demonstrated a good track record.
Check their style. What types of stocks does the fund buy? Is it invested primarily in small, medium, or large companies? Are you comfortable with the investment style?
Check past performance. Find out how the fund did when the market was down. How has it performed over the past few years compared to other similar funds?
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