guidebook on start your investment journey

1

Guidebook on

Start your Investment

Journey

INDEX

CHAPTER-1:

SAVING

&INVESTMENT

Page 03 - Page 13

–

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Saving & Investme

nt Amit, a 26 somethingtechie received a call from Sumit, a financial advisor regarding a new investment plan. Amit replied he did not see any need for saving & investment as hebelieved in living life to its fullest. Sumitunderstood that Amit needed some lessons on the concepts of Saving & Investment. He fixedup a meeting for weekend morning. As expected, Sumit turned up and after introducing himself began explaining thefollowing:

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Chapter 1: Saving &Investment

4

1.1 What is savings and investment?

In simple and general terms, savings is the surplus amount left from your income earned after deducting all the expenditures.

Hence, Savings = Income earned –

expenditures incurred.

Investment, on the other hand is done out of the savings made. This portion can either be invested in long term or short term investments avenues. Investments are intended to provide a cushion against future liabilities or otherwise. It can be for a child’s education, marriage, purchasing

of a car, settlement of EMIs etc.


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1.2 What is Investment?

The meaning of Investment is spending your time or energy on something anticipating income generation or value addition infuture. For example: A farmer ploughs his field on a daily basis under the expectation that he may reap some returns in the form of grains after a specified period of time. This means that he invests his time and energy anticipatingfuture benefits within a certain timeframe.

Once you have read the aforesaid example, now you already know what an investment means, let us understand the term investment in terms of finance:

In finance, the meaning of investment is


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1.3 How is investing different from savings?

As mentioned above, savings is theamount leftaftermeetingexpensesandinvestmen

t

is done out of the savings made to meet future

uncertainties or obligations. While money kept in savings bank accountwill give interest, investment in mutual fund or any other dynamic investment avenue which is a blend of both equity and debt will givea value for money (read that investment can lead to growth of capital). This is where the main difference between savings and investment lies. Also, while investments lead to wealthcreation, savings is merely liquid cash.

In finance, the meaning of investment is

purchasing or creating an asset anticipating an interest income, rental income, dividend, profits or any combination of the mentioned returns. For example: I purchased 100shares of a company anticipating dividend from these shares. In this case, shares are my investment and I am anticipating dividend income from the investment made.

Chapter 1: Saving & Investment

1.4 Why should one invest / why planning for investments is necessary?

You should invest to get the required sum of money for any goal at the correct time. In other words, if you want to achieve your financial goals in life like creating an emergency corpus, retirement corpus,children education corpus etc. then you must start by making an investment plan which will guide you step by step as to how to achieve your goals.

You cannot expect to achieve your financial goals by following blindly the experience and products embraced/practiced by previous

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7 Chapter 1: Saving &Investment

1.5 When to start investing?

The legendary investor, Warren Buffet mentioned “I made my first investment at the age of eleven. I was wasting my life up until then.” Hence, there is no right age to invest. It all depends on your ability to take risk and the foresightedness to get going.

generation. Cost of major milestones have risen manifold in the last 25 years with the growth of Indian economy (read high inflation).There is a good chance of funds shortage as and when your goals come up if you don’t have an investment plan in place right from the beginning.

Practically, you should start investing as soon as you start earning money from your job or business so that you can get the benefit of starting at an early age and your money has a long time period to grow.

Amit suddenly realized that he had been working for little more than 3 years and did not have any substantial savings.


1.6 What care should onetake while investing?

People have a tendency to invest by listening to others including the “so-called” expertson television, newspaper, magazines, neighbor, friends and relatives.

But it may happen that the stock which they are suggesting may be suitable for him/her but not for others since financial net-worth, risk taking capacity and time plays a key role in investing.

Say a stock which looks a very poor investment in the short run could be a very good investment for the long term.

Hence, the right path would be either to give your money in expert’s hand or rather start with your own research.

A novice investor may face gains or losses initially, however, with experience he shall be able to build his own strategies and will be able to invest based on his own wisdom.

1.7 What are various options available forinvestment?

Market is flooded with different modes of investment. However, it depends on the risk aversion ability of the investor as to whether invests in high risk option with greater returns, low risk options with moderate returns or no risk modes available.

Accordingly, the categorization can be as follows:

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Safe zone

s

High risk options

Moderate

risk options

• Realestate

• Gold

• Company fixeddeposits

• Non ConvertibleDebentures

• Shares and othersecurities

• Mutualfunds

• Investments made in bankfixed deposit or recurring deposits for steady returns in terms of interest.

• Investment in National Pension Schemes, National Savings Certificate, Public Provident fundetc

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Chapter 1 Saving& Investment 10

1.8 What is meant byInterest?

Interest is the cost of borrowing funds. It is the amount charged in percentage expressed as Interest rate. In other words, interest is the cost of renting money.

Suppose Mr. A borrows Rs. 50,000 at an interest rate of 5% p.a. Hence, the interest charged for borrowing the funds at the interest rate given will be Rs. 50,000*5% = Rs 2500/-

Chapter 1: Saving & Investment

1.9 What factorsdetermine interestrates?

Interest Rate is used to regulate Inflation by the central banks. Inflation is the continued increase in the general price levels of an economy. On the other hand; interest is the cost of borrowing funds. The explanation given below will make you understand that the primary factor affecting interest rate is inflation.

Let us discuss two main situations:

Tocooldownhighinflation:the

interest rate is increased.

When interest rate rises, the cost of borrowing rises. This makes borrowing expensive. Hence borrowing will decline and as such the money supply (i.e the amount of money in circulation) will fall. A fall in the money supply will lead to people having lesser money to spend on goods and services. Hence, they will buy a lesser amount of goods and services.

This, in turn, will lead to a fall in the demand for goods and services. With the supply remaining constant and the demand for goods and services declining; the price of goods and services will fall.

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As inflation is a continuous increase in the general price level of goods and services so a fall in the general price level of goods and services will lead to a decline in inflation levels.

In low inflationary situations, the

interest rate is reduced

A fall in interest rates will make borrowing cheaper. Hence, borrowing will increase and the money supply will also increase. With a rise in money supply, people will have more money to spend on goods and services.

So, the demand for goods and services will increase and with supply remaining constant this leads to a rise in the price level i.e. inflation.

Inflation

Money

supply Demand

for money


Insurance

Women typically pay lower life insurance premiums Certain health insurance plans provide maternity cover at applicble premium rates Certain Critical Illnessplans offer coverage for diseases specific towomen Some motor insurance companies offer discount on motor insurance

Property &Home

loan

Several states impose lower stamp duty if the property is registered in the name of a woman Home loans are given at lower interestrates some banks offer concession on homeloan processingcharges

Deposits with banks/PostOffice

Some banks offer exclusive facility available to women in terms of minimum balance maintenance & no cost debit cards

Govt of India offers Sukanya Samriddhi Scheme (SSS) meant only for girl child. This scheme offers higher interest rates than most of bank fixed deposits

Basics of Investment Planning 2

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15 Chapter 2: Basics of Investment Planning

2.1 What is investment process?

Investment process means a series of steps taken to construct and manage your portfolio. There are six steps in investment planning process:-

a) Determine what are

yourobjectives

b) Decide a value for yourobjectives

c) Conduct security analysis:

a. TechnicalAnalysis

b. FundamentalAnalysis

d) Construct thePortfolio

e) Evaluate thePortfolio

f) Revision of the Portfolio

2.2 What are the factorsthat determine / affect your investment capability?

a) Family Information - no of earning members, no of dependent members ,life expectancy b) Personal information – age , employability, nature of job , psyche c) Financial information – capital base , regularity of income (regular or contractualjob) d) Present networth- amount of assets already created and any liabilities undertaken like anyloans

e) Past investment experience (ifany)

In short, it can be said that your risk appetite determines or affects your investment profile.


Invest for a long

period

Invest regularly

Start Early

2.3 What are the fundamentals rules of investments?

There are three fundamental rulesof investments:

a) b

)

c)

Start Early Invest Regularly

Invest for a long period of

time

Example: Raj started investing money to the tune of Rs. 5000 pm diligently. He began this discipline at the age of 22 years of age. He was earning a rate of interest of 12% compounded each year. While his friend, Amrita started investing money to the tune of Rs. 10,000 pm. She was also doing this very religiously. She also earned 12% compounded. She started the process of doing the investments month on month, at the age of 30. What is the total investment adding up to at the age of 50 years ofage?


Raj Amrita

Age when investing began

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30

Monthly investment amount Rs.5,000 Rs.10,000 Total amount invested Rs.16,80,000 Rs.24,00,000

Total market value of investments

(approx)

Rs.1,36,56,360 Rs.98,92,554

Cost of waiting/ delaying Rs.0 Rs.37,63,806

As you can see from thetable the cost of waiting / delaying for Amrita isRs.37,63,806. Raj benefited from eightmore years of compounded growth thanAmrita.

Thereforeit is veryimportant to start investing early. More earlier, the better for your investments.

2.4 What are the investment concerns that need to be addressed, while investing and choosing theassets?

The most common concerns that needs to be addressed, while investing and choosing the assets are-

Chapter 2: Basics of Investment Planning

Returns

The return from the investment could be in the form of capital gains, cash flows, or both. A retired person might be needing regular cash flows to meet daily expenses, where as a younger person in working / accumulation phase might be more concerned with growth of his investment for creating a corpus for his retirement.

Capital Protection

The most important aspect of investment is to protect capital. Majority of indiansare risk averse. We feel investments are risky and thus leave most of our saved money in instruments earning low income, without understandingtheeffectofinflation,which reduces the value of our money everyday.

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Risk is part of our lives. There is risk associated with anything or everything we do. Even if we cross a road, there is risk of meeting with an accident. Risk and reward go hand in hand, higher the risk, more is the reward expected.

Each of the investment assets has its own associated risk and reward/return, whichone must understand before investing his money in any of the investmentvehicles.

Inflation

By definition, inflation is the rise in

general

level of prices of goods and services in an economy over a period of time. When prices rise, each unit of currency buys fewer goods and services, resulting in erosion in the purchasing power of money. The aim

of investment is to get returns in order to


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increase the real value of the money. Inother wordsyour investment should be able to beatinflation.

Taxation

Income from our investment assets isliable to taxation, which is going to reduce our returns. You should remember that the real return (read positive return) from any investment product would l be the return after accounting for taxation andinflation.

Liquidity

It is the ability to convert an investment into cash quickly, without the loss of a significant amount of the value of the investment. If you would need a particular amount at a short notice then invest in a investment product


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with high liquidity.

Divisibility

This is the ability to convert part of the investment asset into cash, without liquidating whole of the asset. Divisibility may be an important consideration for many investors, while choosing an investment vehicle. For example, while investing Rs. 15 lacs in senior citizen scheme, one could increase the divisibility without affecting returns by dividing this investment in ticket size of Rs. 2-3 lacs, rather than investing Rs.15 lacs in one go.

Before committing your capital to any investment vehicle, it is preferable to consider your financial needs, goals, and aspirations, as well as the risk profile.

Concerns / Factors for chooosinginvestm

ent

Taxation

Divisbility

Inflation

Returns

Capital Protection

Liquidity


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2.6 What are the various types of Assets?

• •

Financial Assets – cash, debt , equity Physical / Non-Financial Assets

– commodities , real estate • Alternative Assets – art

objects,collectibles

, precious stones and Gold,

2.5 What are the avenues for investments?

The various avenues where you can park your saved money are known as ‘asset ‘in

layman’s language or ‘asset class’

ininvestment

parlance. Broadly there are four asset

classes in India – equity, debt, gold and

cash.

Financial Plan – Concepts& Factors

for Success

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23 Chapter 3: Financial Plan – Concepts & Factors for Success

3.1 What is Time Value of Money?

You have won 10 lakh in a lottery. Given a choice, would you take the 10 lakh as a lump sum in one shot immediately? Or would you prefer to receive it in equal yearly installments of 1 lakh over the next 10 years?

If you are like most people, you will have taken the money immediately. And this is the right decision. This is because of the Time Value

of Money (TVM) which is basically power

of

compounding.

Where, FV: Future Value PV: Present Value R: rate of return

N:Numberoftimeperiodsforwhichthemoney

is invested

Money that is available today is worth more than money available at a later date, because you can invest it and earn a return / interest on it. So, for example, if you had 10 lakh available today, and you invested it into a 1 year Bank Fixed Deposit offering 7.50% in compounding mode, then in 1 year your money would be worth 10.77 lakhs.

The money you save and invest is the Present

Value in your equation.

R is the available market rate of interest – this is not in our control – available investments offer

FV = PV x (1+R)^ n


3.2 Explain - disciplined and regularInvesting

The most convenient and easiest way to accumulate wealth is by investing regularly and in a disciplined manner.

This can be done with any of the asset classes mentioned previously. For example when investing into debt market you can opt for a recurring deposit, or investing into equity you can go for SIP (systematic investment plan).

The asset class that grows your wealth the most over a long period of time is equity. Very often while investing, investors try to get the perfect entry and exit point of the market – which

certain approximate rates of return, and what you can do is choose your investmentinstrument carefully.

The only factor in your control is your N. You can increase your investing time horizon. The earlier you start investing, the higher will be your N,and the greater will be your money’s FutureValue.

PowerofCompoundingistheEighthWonderof

World – Albert Einstein


3.3 What are the benefitsof

investing via a Systematic Investment Plan(SIP)?

3.4 Howinflationcanaffect your financialplan?

Purchasing power is the quantity of goods or services that one unit of money can buy. For example, Rs.100 can purchase much less today than it could purchase say 20 years ago. If your income level stays the same, but the prices of goods or services increases, then it essentially means that the purchasing power of your income has reduced.

This increase in the price level is called Inflation. Thus inflation is the increase in prices that erodes the purchasing power of your money.

And this is the most important factor to account

for when making your financial plan.

Advantag

e of power of compoun

d- ing

Benefits of SIP

Advantag

e of Rupee Cost

Averaging

Enables disciplin

ed

investing

amounts to market timing which is very

difficult

even if not impossible.

Instead of timing the market, try to let your investments spend time in the market!

Aviodstiiming of

market


Purchasing Power of money

Inflation/

Cost of

Goal

Example: Mr. Prajwal Ingle has a 6 year old daughter. He plans to send his daughter to college for graduation at age 18 and post graduation at age 21, for which he will spend 10 lakhs and 25 lakhs respectively. What corpus does Mr. Prajwal need to accumulate for his daughter’s education goals? Assume that inflation in college fees is approximately 10% p.a.

If Mr. Prajwal’s daughter goes to college at age

18 i.e. in 12 years, college fees at that time will be approximately 31.40 lakhs. This is theamount Mr. Prajwal has to accumulate in 12 years to send his daughter for the same standard of college education available today at 10lakhs. Similarly, for his daughter’s post graduation, in 15 years Mr. Prajwal needs to accumulate approximately 1.04 crore to give the same level of post graduate education available for 25lakhs today. This is the effect inflation has had on college education fees.

Chapter 3: Financial Plan – Concepts & Factors for Success

3.5 What is the importanceof Asset Allocation?

Asset allocation is a simple concept which means allocating your investments across various asset classes so that the poor performance of any one asset does not affect the overall performance of the entire portfolio.

Different asset classes are differentlycorrelated with one another. For example, when equity does well, debt or gold may not do well, and vice versa. It is this different correlation that makes asset allocation such a critical component of financial planning.

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Asset Allocation depends upon the following factors:

• Your risk profile (appetite

andtolerance)

• Your financial goal timehorizon

Usually, determining the right asset allocation for you is best done by your personalfinancial planner.

include buying a house i.e. accumulating a down payment in 5 years, sending his son to college in 8 years, and planning for his own retirement in15 years.

Asset Allocation for Mr. Kaustavand Mr. Anand is given as follows :

Asset Class MrKaustav Mr Anand

Example: Equity 70 % 55 % Debt 10 % 30 %

Consider two persons: Mr. Kautav and Mr. Gold 15 % 10 %

Anand. Cash / liquid funds 5 % 5 %

Mr. Kaustav is a 30 year old male who is married and has no children. He wishes to plan for his retirement, and so his goal time horizon is 25 to 30 years. Mr. Anand on the other hand is 45 years old, married and with a 10 year old child. His goals

MrKaustavalready has his allocation to real es his own home.

Mr. Anand is buying a ho accumulating down-pa he

his own house and hence tate is simply the value of

me for which he is yment funds. When he will be


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purchases thehome buyingreal


30

estate and hence adding real estate to his asset classes. He has a lower exposure to equity due to the higher number of goals, their comparative nearness in terms of years, and his higher age which reduces his risk appetite and tolerance.

Mr. Kaustav on the other hand has higher exposure to equity, a riskier investment, because his only goal is retirement, and the time horizon of the goal is 25 to 30 years i.e. long term.

Remember, asset allocation is not a one-time process. It is not static, but dynamic. As your goal draws nearer, it is important to re-assess your asset allocation and withdraw fromrisky investments – to de-risk your goal’sportfolio.

You can decide what your asset allocation should be for each of your goals. Here are some guidelines you can follow in deciding asset allocation:

• If your goal is more than 10 years away, you can invest up to 70 – 75% of your

investiblefunds into equity, depending on your risk profile. The remainder of your investment can be put into debt (15 to 20%) and gold ETFs (around 10%). • As your goal comes closer, for example

when your goal is 6 years away, you can maintain an asset allocation of 60% in equity, 30% in debt and 10% in gold ETFs.

• When your goal is less than 3 years away, it would be wise to not expose the corpus to

equity market volatility. Maintain a 100% exposure to fixed income instruments.


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3.6 What’s your risk appetite and risk tolerance?

Risk appetite simply refers to how much risk one is willing to accept. Risk tolerance indicates how much risk our finances can actuallyhandle. The two might be verydifferent.

Remember, those investors who were invested in equity when the markets crashed in 2008 and in early 2018, and had a goal such as theirchild’s education or their own retirement less than 3 years away, have had to watch their goal funds get eaten away in the market crash. They also may not have had enough time to rebuild their goal corpus. This is why it is absolutely essential to de-risk your goal portfolio as your goal draws nearer.

Risk

Appetite

Risk

Tolerance

Risk

Profile


Example:

Mr. Arka Roy is a young man, married with a child. His risk appetite may be high. This may be based on his investing tendencies, in case he has done well with equity in the past he is confident to do well in the future also and hence has a high appetite for risk.

However, based on his financial situation which comprises factors such as level of emergency fund he maintains, if he has any loan EMIs that are chipping away at his income and so on, his risk tolerance might be very low indeed.

You should assess your own risk profile to know where you stand compared to your own risk appetite and risk tolerance.


Risk profilingis an exercise to determine

how much risk is appropriate for an investor.

Risk profile is subjective. Few persons have the ability or objectivity to determine their riskprofile appropriately. This is done by asking several questions as part of a structured data gathering exercise. Examples of few such questionsare:

What is your age?

A young investor will have a higher risk taking capability than older person due to sheetfact that he has more time on hisside

How many earning members are there in the

family?

If number of earning members are high then risk taking capacity goes up but if there is only one earning member then he can have lower risk

taking capacity.

How many dependent members are there in the

family?

How stable are the income streams in the family? If the job is a permanent full-time one as compared to a freelance consultant then the person will be having a higher risk taking capacity

.

What is the level of the investor’s current wealth, in relation to the fund requirement for

various needs?

Already if the investor has gathered substantial asset then he can take on higher risk,

What is the liability and loan servicing requirement of the client?

If the investor has single or multiple loan EMI

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Chapter 3: Financial Plan – Concepts &Factorsfor Success 33

running then a major portion of income gets eaten up by such liabilities leaving littlesurplus for investing and taking risk.

If the market were to fall down by 10%, how will

you respond?

The investor who believes in increasing his position when the market falls is obviously comfortable with risk and losses. If a market fall were to trigger an exit from the investment with whatever can be recovered, then the investor

is not a candidate for risky approaches to

investment.

Such questions help in understanding the psyche of the investor and accordingly asset allocationis customized for the investor.

Chapter 4: How to plan for your life-stage

How to plan for your

life-stage You must have heard the thumb rule of how much to invest in equity. It states that you should have (100 - Your Age) % of your net wealth in equity. So if you are 40, you should have 60% of your net wealth in equity.

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Chapter 4:How to plan for your life-stage

But is this necessarily correct?

Your equity exposure depends on the proximity to your goals, and it is very doubtful that anybodyhas only 1 financial goal in their lives. So a single equity percentage based on your age cannot apply.

Two generations ago, life was comparatively much simpler financially. You would go to school, maybe to college, get married in your 20s, have children by your 30s, work in one company for almost yourentire working life, buy a home on retirement, and retire peacefully by 60.

Things are different now. Creating a successful and powerful plan for your financial life in today’s times has very little to do with your age and a lot to dowith major life stages / events when you make the plan.

Let’s see what these life stages / events are and what the best approach is to deal with your finances in each one.

Chapter4:Howtoplanforyourlife-stage 36

Low bank balance

Financial Goals limited

Nofinancial dependent

s

Unmarried

Starter Salar

y

Low tax incidenc

e

4.1 Stage 1 - Your First Job

You’ve graduated and just got your first real job. A critical concern at this time is managing your cash flow.


4.1.1 Startsaving.

Although you might feel like you don’t have the money, even saving 10% of your income per month is enough to start planning for your retirement. If you’re 23 years old and in your first year of working you manage to save and invest Rs. 24,000 (Rs. 2000 a month for 12 months), then at a growth rate of 15% per annum this Rs. 24000 will grow to Rs. 36.75 lakhs by your age of 60.

4.1.2 Insurance

you most likely have no financial dependents at this time so you might not need life insurance, but you should definitely opt for health insurance. This has dual benefits - firstly, your health is insured and this is most important. Secondly, you can claim a tax deduction of the premium paid, under Section 80D.

4.1.3 Tax EfficientInvestment

If your salary brings you into the 5% or 20% tax bracket, the first thing you should do is avail of Section 80C deductions - invest into an ELSS fund (equity exposure) and into your PPF / EPF account (debt exposure). The limit is Rs. 1.50 lakh under Section 80C.

4.1.4 ContingencyFund

Start building up a contingency fund for use only in case of emergencies. Typically this should be the equivalent of 6 to 12 months of your monthly expenses - depending on your personal risk appetite. Set this aside into a liquid mutual fund to earn a better rate of return than your savings bank account. But remember that the aim of this fund is to enable liquidity of money and not just high returns.


4.2 Stage 2 - GettingMarried, Having Children, Life Goals Increase

If any equity investments are done at this stage and held for a long period like 5 – 10 years or even more would most likely generate a high rate of return, and therefore beat inflation. At this stage of life, equity can be taken for the long run.

Married, with or without children. May have or take a home loan /car loan

Personal goals would include pro- gressing in your career, caring for your family (parents, spouse, children if any), enhancing lifestyle (vacations, car, other regular lifestyle expenses)

List of financial goals might include planning for children’s education & marriage, house purchase, own retirement, providing for parents, purchasing a property as an investment to yield rental income

May or may not have adequate life insurance. May not have adequate health insurance for the family

Need to grow wealth, increase contingency reserve


4.2.1 Insurance

the first thing you should do is checking your life insurance requirement. Buy life insurance in the form of a simple term plan and not any other type of product. The premium for a term plan is the lowest; the cover you will get for this premium isthe highest. This is the best way to protect your familyin case of your untimely demise, especially if you also have any liabilities like a home loan / carloan.

A financial planner can help to do an exact assessment of your insurance requirements and suggest the most suitable policy from the universe of hundreds of policies. Also, for health insurance - take a family floater that covers your dependents. Ensure that you have sufficient cover for each member of the family, considering that medical costs can be quite

high these days.


4.2.2 Different Kinds ofLoans Available and How to Ensure You Don’tOver-Borrow

Unsecured Loans - An unsecured loan refers to any kind of loan that is not attached by a lien on any of your specific assets. This means that in case you default on the loan due to bankruptcy or any other reason, the unsecured debt lender does not have the right to claim any specific asset. Example - credit card debt & personalloan

Secured Loans A secured loan is one where you, the borrower, pledge some asset of yours as collateral to the loan. In case of bankruptcy / any other reason for defaulting on the loan, the lender has the right to take possession of the asset and sell it to

recover some of his loss.

40

Example - car loan & home loan.

Thus there are many options of loans and different lenders (from banks to housing finance companies to your relatives), whichcan help you take a loan when you need one. Now you face the question of how to ensure that you don’t over-borrow and put a strain on your finances.

A simple way to check whether you are over- leveraged or not is to find out your Debt to Income Ratio.

Formula = Sum of monthly outflows / EMIs / total fixed monthly income

Ideally, this ratio should not be more than 30%, else you might be exerting strain on your income to service your debt.


4.2.3 How to Build your Wealth with aLoan?

Taking a loan can be a great way to build your wealth provided you know how use it smartly within the laws of land. For example home loan & car loan can help you achieve the financial goal of buying a home or a car (by making payments over a period of time) without having to wait and save enough to make an outright purchase by paying in lumpsum mode.

In case of home loan, there are tax benefits both on principal repayment and interest payment.Since you are not going to pay in lumpsum but via EMIs so it provides a way to build an appreciating asset like a residential flat.

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4.2.4 How to save to buy ahome?

You can follow the steps given below to ensure savings to buy your dream home:

Don’t let credit card debt suck you dry

If you have a large amount of debt then there is no point trying to save money as the interestyou’ll be paying on your loans will faroutweigh any return you will see on any savings. You need to get rid of your accumulated debt first.

Also, before you take a home loan, you should put yourself in a position where you do not have any other debt to service. Not only will that free up cash to service your loan but you will be able to take a higher loan simply because you are not

bogged down by other such payments.

So the first step is to clear your personal loans

and credit card debt.

Start saving with your very next paycheck

You can start investing in an equity fund if you plan to take loan years after some years. Start a systematic investment plan (SIP) where a small amount gets channelized every month towards an equity mutual fund. If you do not have a long way to go, opt for debt mutual funds and select that type of debt fund which matches your time horizon and risk appetite.

Stop the outflow of expenses

Curb your expenses and you will be surprised at how the small savings add up. You can start by eating at home. Reduce your eating out budget


and you will see what a big saver that is. Not to mention much healthier. Cut down on cigarettes and alcohol too. Not only will you be healthier but even richer. Cancel unnecessary magazine subscriptions. All these small moves will impact your bank balance positively.

Act on a definite plan

Do you have an idea how much the house is goingtocostyou?Forinstance,ifyouplantobuy a home that costs around Rs 50 lakh, then you will have to ensure that you have Rs 10 lakh as a down payment. So work with definite figures or else your savings may fall way below the actual amount that you need. Also, work with a time frame. Do you need that amount within a year or within five years? Once you determine that, the actual investment avenue can bedetermined.

Monitor Credit Card debt

Start saving with next

Stop the outflow of expenses

Act on a definite plan


4.2.5 What is an EMI and how are EMIscalculated?

The Equated Monthly Installment, or the EMI,is the amount of money paid by borrowers, each calendar month, to the lender, for clearing their outstanding loan. Generally, EMIpayments are made every month on a fixed date, for the entire tenure of the loan, till the entire outstanding amount has been completely repaid. The EMI depends on the loanamount,

the rate of interest and the duration or the

time

of repayment of loan.

Home loan providers offer different varieties of loans that are designed to fulfill the diverse needs of home buyers. But,

before opting for

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the right one, it is important to understand the

most integral part of any loan, and that is EMI.

So, let us understand the composition and how is EMI calculated?

TheComponentsofEquatedMonthly

Installment (EMI)

Interest

EMI

Principal

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4.2.6 Rising Loan Interest Rates– What should youdo?

The most common option when the interest rate goes up is to either increase the EMI or increase thetenure of the loan. But there are other options too besides these as mentionedbelow:

Increasing the loan tenure and keeping the EMIconstant

When interest rates rise, a sudden rise in EMI could be quite a pinch especially for individuals in tight financial conditions, those with more than one debt and those nearing retirement. At such times, keeping the EMI constant and increasing the loan tenure works out as an ideal option.

Lenders accommodate the interest rate increase in the increased loan tenure and retain the monthly outflow at the same level. However keep in mind that by doing so in the long run, you end up paying more

interest for your loan. Increasing the EMI, with the same loan tenure For those who can afford it, go for a higher EMI and maintaining the same loan tenure. This is because, by increasing the EMI and retaining the same loan tenure, though the monthly outflow is higher, the total cost of the loan works out to be much lesser.

Loan Prepayment

For many borrowers, loan prepayment could be the last option in times of high interest rates, as it primarily depends upon the liquidity position. When going in for a prepayment, remember to check on the prepayment charges the lender would quote. Consider prepayment only if the cost of prepaying the loan works out to be much lesser than the rise in interest rate.

Loans could also be part prepaid. By doing so,

the

loan principal value comes down, thus reducing

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the total interest amount you’ll pay. The EMI would reduce, or at least, the same EMI would remaineven after an interest rate increase. Some banks may not even charge a penalty for up to a certain percentage of prepayment. A combination of a part prepayment with a marginal EMI hike could sometimes work out as an ideal option, if funds are available to doso.

Now comes the big question - when is the best

time

to prepay a loan?

This question is quite relevant for home loans, as the amounts (and thus, the interest) involved isvery large. Towards the end of a loan, you are mostly paying the principal and very little ofinterest. Whereas towards the beginning of a loan, you are mostly paying interest, and very little in terms of repaying the principal. Therefore, if you repay the loan towards the beginning, you would be saving a lot more on the interest than if you repay the loan towards its end.

Loan Refinance Loan Refinancing is replacing your existing loan, with a new one, under fresh terms andconditions. When interest rates rise, switching over to a lender who is offering a reduced interest rate, could serve to be a good deal. For a charge, you could switch over from a fixed to a floating rate, or vice versa.

Manylendersaremorethanhappytoattract borrowers by lowering their interestrates. However this process does not come easy. Be ready for a lot of paperwork along with foreclosure charges, and processing fees.

Chapter4: Howtoplanforyourlife-stage

47

Increasing loan tenure and keeping EMI constant

Increasing EMI and keeping the loan tenusresame

Loan prepyament

LoanRefinance


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4.2.7 Why It Is Sometimes NOT Better ToPrepay YourLoan?

It is not necessary always that prepaying make financial sense. Simple reason is the opportunity cost of your money.

For example, if you have a loan which ischarging you interest at 10% p.a., and you suddenly come into some surplus funds which you can either use to prepay full or part of your loan, or to invest, the first thing you should do is check the opportunity cost of these surplusfunds.

Would it make more sense to prepay the 10% interest loan, and thereby save yourself from paying the 10% interest? Or would it make more sense to invest the funds into an investment

product that can generate more than 10%

return -

based on your risk appetite and time horizon? So remember, if there is an investment instrument which would give you a long termrate of return that is higher than the rate of interest you are paying on your loan, it makes financial sense to invest the funds and earn the higher rate of return, than to prepay the loan (in full or in part) and save yourself the lower rate ofinterest.


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4.2.8 What to Do When You Find Yourself in Too Much Debt?

If you find yourself in a situation where youfeel like there is too much debt to handle and you need to get out from under the debt as soon as possible, there are some simple steps that will certainly help:

DoNotIncreaseYourLiabilitiesIfyoufindthat you are already stretched, you may find that well-wishers are advising you to take another loan to pay off your existing loan. You would simply be delaying the time when you do have to sit down and pay off thedebt.

Do not add to your existing liabilities by taking on more loans. Once the existing liabilities are cleared, if you find that you need to takeanother loan – make sure it is easily serviceable by your existing, fixed monthly income, and the terms (tenure, rate of interest) are suitable to you. This should be done only after your existing liabilities have been paid off.

TakeStockofYourLiabilitiesMaintainaPersonal Budget. This simple and oft ignored tool is an excellent resource in your battle against debtand by maintaining a good personal budget, success against debt isachievable.

A personal budget will help you discover the

following:

Your exact cash flows your fixed monthly


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incomes and all your monthly expenses. Once you know your expenses, you can see whereyou are spending on luxuries – and rationalize this portion. Spend on the necessities only, save the rest. Calculate an approximate figure of how much extra money you can save each month – and allocate it towards a debt repayment fund.

Your exact liabilities You can track exactly

what

debts you have and all their details.

Create a table which contains all details of the various loans taken, loan type, each loan’s outstanding tenure, EMI, rate of interestand outstanding amount. The rule to be followed is pay off the highest interest rate debt first. Loans restructuring can be done in two ways. First, restructure your loan for a lower Interest rate. Second, refinance your existing high rate loan by taking a fresh

loan at a lower rate.


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4.2.9 ContingencyFund

Now, you need to assess your contingency (emergency) reserve. This should be 6 to 24 months of your monthly expenses, including EMIs if any. Hold this in a liquid mutual fund scheme. This should be used only in case of a financial emergency, which can occur at any time. Do not use this for big ticket expenses like contributing to a new car or a vacation.You never know when an emergency might occur and how much cash you will need. Think credit crunch year2008.


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