One doesnâ€™t need to understand the working of an engine to drive a car. One also doesnâ€™t need to understand an operating system to use WhatsApp or Google maps.
The same is true for investments and personal finance. One doesnâ€™t have to be an expert in economics or accounting and politics to be good in personal finance. All one has to do is follow certain rules, ones that are universal like the law of gravity.
Personal finance is both a simple concept as well as a complicated one. Simple, because all the maths one needs to understand for personal finance are covered in fifth grade, and complicated because the human brain is not designed for savings and investing.
Our mental and emotional thought process is based on millions of years of evolution. Birds naturally know how to fly; fish knows how to swim â€“ itâ€™s a part of their DNA. Similarly, how we humans think and behave is organically programmed due to evolution. The biggest enemy for our portfolio is our own behaviour.
There are some simple facts to investing. Equity has the potential to beat inflation in the long run. Fixed income gives returns more or less in line with inflation. And gold is an asset class that can be a good hedge for inflation and uncertainty in the long run.
It all boils down to having a right asset allocation.
The higher returns that equity offers over fixed income are not free. Nothing in life is free, especially in the world of investing and finance. The extra returns that equity offers over fixed income come with a price tag of volatility and uncertainty. Even if equity gives 2â€“ 3 per cent more than fixed income in the long run, itâ€™s worth taking the risk. Two-three per cent difference over 20 to 30 years can be huge. Think compounding.
Investing in stocks or bonds without reading the balance sheets and understanding valuations of a company is like playing blind. If one seeks advice and tips from others, he or she is not fit to invest directly in stocks or bonds. Investing starts with one acknowledging oneâ€™s limitations.
Mutual funds are the perfect solution for people who want to own stocks without doing their own research.
What we eat makes a huge difference on our body. What we consume, watch, read and surround ourselves around also have a big impact on how we behave. Human brains are not designed for 24×7 information, where every hour, there is a breaking news. We consume information that has an expiry date of a few days to take decisions for goals that are decades away.
In todayâ€™s world, we donâ€™t need excess information. We need process and noise filters. In investment, we have to take decisions with incomplete information, and this brings a lot of anxiety. This is what makes investing crazy, and at the same time, interesting. Investors who understand the principles of personal finance prepare for rather than predict the market.
Their portfolios have enough equity to capture the upside in bull markets and enough debt to withstand bear markets.
If one is trying to put in an effort to make more money with a small investment within a short period, itâ€™s not investment; itâ€™s called speculation. There are no short cuts in investing. Wealth gets created not on the basis of IQ alone, but with patience and discipline over decades by giving time to the portfolio.
In the long run, itâ€™s not just how much money one makes that determines future prosperity. Itâ€™s how much of that money one puts to work by saving it and investing it.
In investment, one should look for effectiveness rather than efficiency. Your family will not ask you how much returns you made. The only benchmark should be financial goals. You canâ€™t tell your child that this year you cannot pay their fees as markets have corrected 30%. You also canâ€™t tell your wife you cannot promise her a comfortable retirement as you saved less, and played safe by investing only in fixed income.
The brain is the most overworked organ in the human body. It consumes almost 80% of the bodyâ€™s energy. The brain starts taking short cuts if we keep troubling it to take many financial decisions.
These short cuts are bad for investing. One should automate personal finance. Automation through SIP in equity, debt and gold is a good way to building an investment plan. One should automate with the right asset allocation.
Mr Market has many moods. There are days when itâ€™s happy and there are days when the mood is bad. Mr Market also goes through periods of depression and ecstasy. Following Mr Market on a daily basis can be a big distraction and may lead us to taking wrong decisions.
Gambling and speculation produce chemicals such as adrenalin and endorphins in the brain. Itâ€™s addictive, entertaining and makes for a good party conversation. On the other hand, the principles of personal finance are boring. Always have a picture of your family when you invest and consider if they would appreciate and approve of this.
We all say we want simplicity, but the fact is, we all get attracted towards complex ideas. A good financial plan is the one, which is simple. It should be so simple that one can explain the entire financial plan to a child or spouse in less than the time it takes to prepare Maggi noodles. After all, it pays to keep it simple for happy investing!
(Amit Grover is AVP for Learning & Development at DSP Investment Managers. Views are his own)