Don’t just put your money to work – Make your money work right!

It is true.  Money does make money for you, but only when it is provided the right guidance.  Just like you don’t ride a racing car on the city streets, you shouldn’t invest your money into instruments that gives you 5% return when it has the potential to shower you with atleast 20%.  But that doesn’t mean you can do the same with all your money.  If you do that, just like a scooter looses its balance if you try and speed up beyond its limit, your life too will.  Therefore, depending on your time horizon and liquidity requirements, if you invest your money into right instruments, your money just don’t make money for you, it helps you achieve your goals, without compromising on your risk appetite.  Actually one should determine his goals and allocate money for each of such goals in a rationale manner.  This is nothing new, you must have read it in a number of blogs, but I just thought of writing on it because I think one consolidated guidance on choosing the right investment option is required.

As mentioned in my previous blog, the first thing one must do when he starts earning is to determine the need for emergency fund.  My definition of emergency fund is an investment which is totally liquid and available at your disposal as and when needed.  Now the question is how much should be the emergency fund.  According to me, an emergency fund of 5 times your monthly expense should be sufficient (a news report in The Economic Times suggests that 6 times your monthly expenses is reasonable which you may consider).  Here I am making an important assumption that your health is sufficiently insured.

After the emergency fund is determined, start identifying your goals, the amount required for each goal and more importantly time frame within which each goal needs to be achieved.  For example buying a house is a goal and need to buy it in 5 years is the time frame.  Now one should segregate all these goals into the following categories:

  • To be achieved within a year
  • To be achieved after a year but within 3 years
  • To be achieved after 3 years

Based on the above segregation, one can determine which instrument should be used to make the most of your investments ie ‘make money work right’. 

  • Emergency fund: Emergency fund should be invested in instruments which gives liquidity.  These funds should be available over-night in case of emergency.  There were days when you had to keep your emergency funds in the form of cash.  Then came the days when you had to keep it in savings account which gave interest at the rate of just 4% per annum.  However, thanks to internet banking and ATM facilities, one can keep the emergency funds in fixed deposits (which can be liquidated before maturity and has facilities like sweep in credit) with interest rate of approx. 7% to 7.5% per annum.
  • Goals to be achieved within a year: Funds for goals to be achieved within a year should also be invested in fixed deposit, as other investment options comes with either a lock-in period of more than a year (eg bonds etc) or its risky to invest in such instruments for a period of less than a year (eg share markets, mutual funds). As mentioned above, fixed deposits can only give return of upto 7.5% per annum.
  • Goals to be achieved after a year but within 3 years: Funds required for goals to be achieved between 1 to 3 years should be invested in debt mutual funds. Debt funds are considered to be relatively safe and give returns which are little over prevalent fixed deposit rates ie around 10-12% per annum.  As per the analysis by Value Research – a well-established investment advice and analytics firm, the probability of losses in debt funds is virtually zero if the holding period is more than a year.   Therefore, debt funds are the best option for creating a fund for the goals to be achieved between 1 to 3 years.
  • Goals to be achieved after 3 years: Funds required for goals to be achieved after 3 years should be invested in equity mutual funds. Equity mutual funds are basically funds which primarily invests into equity (share market).  Experts fund managers managing such equity mutual funds invests into diversified portfolio to reduce risk.  Fund managers are the one’s who have mastered the art of choosing the right stock and right time to enter and exit, minimizing the risk of losses and increasing the possibility of getting higher returns. 

Equity mutual funds are directly linked to the share market it is a risky investment to the extent that it can even erode your capital.  However, an average investment period of over 3 years should minimize the risk of making losses to minimal or rather negligible. 

This is supported by a recent analysis published in The Economic Times.  As per the report, an analysis of equity funds conducted for the period of 10 years from 2007-2017 (which includes period of financial crisis as well), at any given point of time if a person invests in an equity mutual fund for a period of 3 years or more, the probability of making a loss (ie losing capital investment) is negligible. 

Directly investing into equity market is also an option if the investment horizon is more than 3 years.  However, one needs to analyze and regularly follow through the stocks to make money in the equity market.  It is not for the people who are not good with analyzing the balance sheet and other financial ratios of a company.  Even if people are good with this, choosing the right company and determining the right time to enter and exit is an art, not everyone can master. 

Good investments can even give 100% returns in the span of a year whereas bad ones can make your capital half in no time.

Given that we are here considering a definite financial goal say buying a home after 5 years and assuming we all are not that smart to master the art of equity market, I would not recommend this route unless you have sufficient money to invest with no goal in mind.

The above guide will help you not just make money by putting your money to work, make the best of it, by making your money work right. 

For completeness, let me mention other investment option like PPF, bonds etc which typically have returns as much as fixed deposits or debt funds, but comes with a lock-in of 3 years or more and therefore I would not recommend investing into those instruments unless you are amongst those who think that any money with private parties is not safe and therefore only option is instruments secured by the government.

Gold ETFs and real estate are also good options but frankly speaking I am neither an expert on those nor I think I want to be, given the other relatively safe, liquid, seasoned, time tested options available which have been discussed above.

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