Realistic Principles of Building An Investment Portfolio! Investing Guide 101

Hey!

What's good you guys!

I hope you all are doing absolutely great and having fun.

You must have guessed through the title what's coming your way. In a country like India which is this career fuelled and career-driven, most people are employed and earn a decent amount of salaries from their jobs but most of them are ignorant about managing their money in their early 20s. Although, I am no one to guide them on how to manage their money rather I would like to create awareness among the people to enhance their financial literacy and make them more enthusiastic about money management. You are free to correct me anywhere if I am wrong and I shall accept it gladly. But before that, let's just dive straight into the ideas and create an intellectual space to live in.

According to your age, what should be your investment mix? Have you ever wondered about it? No? Don't worry we will get to know all about it here. Guys, this is a question that a lot of people have asked me, I am 25 years or 35 years, or 45 years old, but I haven't started investing yet, so what should be my investment approach? What should be my investment mix? There are stocks, fixed deposits, corporate bonds, gold, real estate, and cryptocurrencies too. What should be the mechanism to evaluate all of them? And what should be their share?

Some of the common questions going through your mind

In this blog, I'll try to elaborate on all these above points. Basically, in a broader space, I will try to answer 3 essential questions:

1. Irrespective of your age, what are the things you have to bear in mind before you even start investing?
2. How to make an emergency fund? and what's the approach to it?
3. How much should be your investment approach, and what should be the portfolio mix?

Number 1, before starting investing no matter what your age is, be it 22, 32, or 50, there are two things you need to have and I say this very often, but it never harms to repeat it again.

Things to bear in the mind before starting to invest:

• Health Insurance for your family

Since your parents are older by age, their health insurance is generally more expensive. Moreover, for a family policy that includes you and your dependents (your parents), the insurance premium is charged based on the age of the oldest member making the premium expensive. Hence, general advice suggests taking separate insurance for your parents and yourself.

So, have a separate health insurance for yourself, your parents, and your family. If you are married or having kids, separate health insurance is necessary for them. In the past two years, the things the world has seen, hopefully through that you may have realized that health insurance is very very critical.

• Life insurance for your family

God forbid if anything happens to you and you are the earning member of the family, and the only earning member then you would never want that when you are not there and the income stops, your family should suffer at all. So, for them, financial security is very important. Take the life insurance. Term plan is the best plan where you could give the lowest premium, and get the highest coverage. Whatever is the annual income, your term insurance cover should be 20 or a maximum of 25 times the annual income. So, if you earn Rs. 5 lakhs annually, then a cover of 1 crore or ideally a cover of 1.25 crores should suffice. 

And above two things are critical before you start any investing journey

Building an emergency fund

After this let's come to an emergency fund. An emergency fund is for those scenarios in which your income stops for a short period situations as you have been fired from your job or you are on a sabbatical, you have undergone an operation, you have any chronic illness, or because of any family reason, you had to stop working, whatever the reason may be but there is an unpredictable emergency. So, you need to have money at that time. The minimum emergency fund amount or size should be at least 6 months of your basic monthly expenses. and ideally 12 months of your basic monthly expenses. 

What are basic monthly expenses?

Basic expenses = needs!

The things that are your needs. Your Rent, EMI, food expenses, electricity and water bills, the things that you need, do not desire, and are not even your investments. Just your basic needs. 6 times is the minimum and 12 times is the ideal amount. You will first build the emergency fund. Forget about investing now because an emergency can come unannounced at any point in time. 

This emergency fund can be divided into 3 parts, 70-20-10. 

1. 70% of this emergency fund should be in a fixed deposit. A fixed deposit is an excellent way to rather protect your money than growing it. Ensure that anywhere, whatever fixed deposit you use, you don't need to pay any penalty amount on its termination.
2. 20% should be in your bank account. It's in the savings. Yes, the money is rusting there at 2%-3% but that's the basic need for an emergency fund. Don't worry about it.
3. Then 10% should be liquid cash at any point in time at your home if the need arises. That should be the split of an emergency fund. 

And with the life insurance, health insurance, and the emergency fund, you are now ready my friend to start your investing journey

Basic 50:30:20 Rule

So, we are ready to dive into investing after carefully ticking all the boxes above. Right!

To invest, the basic rule that is used is called the 50:30:20 rule. Often, when people think about investing they generally think that what's the point of investing. We are 25 or 30 years old, it's the time to enjoy life because we have just started earning money. We want to buy good clothes, party, go out on vacations, and buy expensive stuff! and if we put all our money into investing then we'll get the money when we are old, what's the point of it? When we won't have teeth and strength in our body what are we going to do with that money? This is how most people think nowadays, and this is where budgeting comes in.

Budgeting allows you to have segregations for each and every purpose of your life. 

The 50/30/20 rule was popularized by Senator Elizabeth Warren (a Harvard law professor when she coined the term) and her daughter, Amelia Warren Tyagi, in the book All Your Worth: The Ultimate Lifetime Money Plan. It was designed as a rough rule of thumb for working-class families to plan their spending to prepare for the future and unforeseen circumstances. 

Well, there are other budgeting techniques as well viz-a-viz 80-20 budgeting technique and 70-20-10 budgeting technique as explained above. It is not necessary to go only for one method, it all depends on your income and basic expenses and which budgeting technique will actually suit you. Feel free to implement it accordingly.

The 50:30:20 rule says whatever your monthly income is, 

1 - 50% of it, 50% and no more should go towards your needs such as your EMI, rent, food, clothes, electricity, school fee, etc. i.e. the basic needs without which you can't live your life. That is where the 50% of your income goes but no more than that. 

2 - 30% then goes towards your wants, mostly your desires. It may be your phone, laptop, car, vacations, parties, dining out, entertainment needs, and whatever it is that you wish to do, you absolutely should do it but you have to do it within this 30%. If this 30% is not enough for that month because you want to make a bigger purchase for example - you earn 50,000/- per month after tax deductions and all of that. 30% will amount to Rs. 15,000/- and you want to purchase a phone which is costing you around Rs. 45,000/-. So, you can't buy that phone in a single month and hence, what you have to do is to plan that if you can dedicate this Rs. 15,000/- towards your desires every month but you'll keep aside all your other desires for 3 months. You can save Rs. 45,000 and buy that phone and after that start the same cycle of keeping the 30% amount aside for your other desires subsequently. That is how you have to think about your budgeting.

3 - 20% is the bare minimum that you have to invest every month with complete discipline and there shall be no escaping this. To ensure that the 20% amount essentially goes towards your investments, do this simple maths:

Needs + Desires = Income - Investments

Keep aside the investment portion of 20% aside as soon as your salary is credited to your account after which you can move towards your expenditures for your needs and desires. That's how you shall be able to religiously invest every month in a disciplined manner proportionately.

So, the investment of 20% is all we need to go about making this, deciding the splits, and the most important determinant to all of this is your age. Your age is a very strong proxy for the kind of risks you can take. If you are fairly young about 20-25 years of age then you can take a lot more risks. This doesn't mean that you are risk-loving but this actually means that you are a risk-averse investor i.e. even if your investments take a loss for a shorter period or get some material impact you'll have the time to recover from it and that is what is called risk propensity at an early age. But if you are in your late 30s or 40s then its highly likely that you'll be having a family and hence your expenses and needs will be more as compared to the people in their 20s and hence, you can't take that amount of risk and if any of your investments take a toll then you won't be having a sufficient amount of time to recover from that because the needs will also keep on increasing with time. So, your age is a very important determinant of what kind of risks you can take. This is sufficiently a good guiding light but not a thumb rule for everyone.

How much risk should you take according to your age? 

So, if your age is X then, 100-X is a very important number because that number tells you how much risk should you take. 

If your age is 25 years old then 100-X = 75 and that means 75% of your investment portfolio can go towards risky assets what are these risky assets? These assets are not bad assets or something you will be gambling but they are really volatile as compared to other assets such as Stocks, and cryptos which will go up and down over a short period but in a long run they are bound to give you positive returns. So, if you ignore this short-term volatility and movements, you'll be having healthy returns coming into your portfolio over a long period.

And the remaining 25%, if you are 25 years old as an example taken above, that 25% of total investments can go towards stable and fixed assets which are those assets that will give you a predictable return but would never be an exciting return. It is required for stability. For example - your fixed deposits, long-term investments, national pension schemes, and so on and so forth.

If your age is 25 years old, the equation becomes

100 - X = 100 - 25 =  75

75% - Risky assets

25% - Stable assets

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If your age is 40 years old, suddenly the equation changes

100 - X = 100 - 40 =  60

60% - Risky assets

40% - Stable assets

Now what are these stable assets and risky assets. Let's dive into it in a detailed manner about the mix and choices of these assets in the portfolio. But before that, we need to save taxes. The government gives us a lot of chances to save tax and we have to maximize all of that because why should we pay the money to the government which ought to be ours if we plan our taxes properly.

Saving Taxes with stable investments

The government is allowing us to plan and save on taxes and thus, we have to be smart and act accordingly rather than being ignorant about it. So, you will cover the % of your stable investments with your tax - saving plan. It may be your EPF, PPF or National Pension Scheme (NPS). If you want to take a little more risk then you can go for ELSS i.e. equity linked savings scheme. 

All these funds and schemes come along with a lock-in period

ELSS for example - comes with a 3 year lock in period. 

If you have PPF - Public provident fund then it comes with a 15 years lock in period. 

EPF doesn't have a lock in period but ofcourse, it has a limit so you can only invest upto a certain limit.

But the idea is whatever your stable investments are, which is the X % as stated above i.e. your age, you will try to cover all of it with your tax savings. 

If you have a home loan its interest amount also goes into the tax savings. 

The premium amount of the health insurance or the term insurance you opt for, gets deducted from your income and becomes non-taxable. 

So, there are a lot of ways in which we can save taxes. We get an exemption upto 1.5 lakhs in ITR. We should avail that at the first place and we can get more of it as the policy changes with time. But the main idea is that we should claim all the tax benefits that the government allows on our part. 

Gold and Real estate investments

Even after all of this, if X% of your stable assets doesn't get fulfilled then a good stable asset to buy is Gold. Please don't prefer buying gold in form of jewellery. Gold is to be bought in the form of digital gold/gold format. A good option of that is called the Sovereign Gold Bonds or SGB. Government announces this every quarter and whenever you buy it you get the gold appreciated returns and a return of 2.5% over and above that as well. So, it's a fairly stable investment to make. Over the last 30 years gold has given an average of 8-10% returns every year. So, if you add another 2.5% over it then at 10-11% its a very good stable investment and you can definitely go for that. 

Real estate becomes another stable investment but it will only be applicable if your X is fairly big and large which is why it is advisable not to make investments in real estate at a very young age by piling up home loans early on because you don't have that quantum and it doesn't give much of a return in certain scenarios. Real estate has never beaten stock market and this is not something you should do at an early age but at a later age, when you enter your late 30s and 40s and you have to invest 40-50% in stable assets, then you can invest in real estate too and ideally in commercial properties because residential properties doesn't yield much return. In commercial real estate, you ll get a higher rental yield and that is something which you can do. 

Now let's jump towards high return and high risk assets!

Stock market investments

In high return and high risk assets, the best asset is the stock market (Indian and US stock markets). 

You could directly purchase the stocks, but that requires a lot of research and you may or may not have the ability to do that initially. Instead, you can buy a portfolio of stocks. In portfolio of stocks, there are two options : 

• Mutual funds
• Smallcase

1 - Mutual funds are great if you want to track the general market or industry. Hence, the most desirable mutual fund is to just buy a NIFTY 50 index fund which is India's top 50 stocks. There are lot of options to that such as HDFC, Axis, SBI, Mirae asset etc. Almost every bank has NIFTY 50 index mutual fund. You can invest in it through SIP (Systematic investment plan) which is great way to do that. As the India's economy progresses, likewise your investments will also grow with it and will give you the benchmark returns. It's the most easiest way out of all with least headache, faith in the experts, low cost instruments and a very good return over a period of time.

2 - Smallcase is great because it represents an idea. So, if you want to buy all the stocks of TATA but you don't know the form in which you should buy it, so you can buy a house of TATA smallcase. I, personally, buy the smallcase of momentum strategy which rides on the short-term momentum of stocks that are increasing and as they grow, they grow a little more before they start dipping. So, they take the bet on that small period which fetches high returns but is very risky and I am willing to take that risk because it lies in my 100 - X%.

So, these are the ways you can actually invest in high risk, high return equities. 

Cryptocurrency investments

The next one is crypto investments. Crypto is again your personal choice. If you believe in the underlying technology and have a decent understanding on it, then you can do it otherwise you can also choose not to indulge in it. Don't invest in crypto due to FOMO because that is the wrong way to invest in crypto. Try to understand every bit of it before entering into crypto market.

I personally invest in only 5 crypto coins. I don't invest in any meme coins or new penny coins. I invest in Bitcoin, Ethereum, Solana (Metaverse), Matic and Luna (DeFi). My investment goal is to own 1 bitcoin, 10 ethereum, 100 solana, 200 luna and 10,000 matic coins. That is what I am going towards which is around 1 crore investment in today's date. So, in the whole month, whatever my investments are, I gradually buy these 5 coins in proportionate manner and that is something I would like to recommend you as well if crypto is something that you believe in. 

Alternative to fixed deposit instruments

A lot of people say that let's invest in the fixed deposits because it's very stable and here I would like to share an alternative to the fixed deposits with you.

Fixed deposits may not be the best for you, because on fixed deposits :

Tax is applicable and if you are in the highest tax bracket which is 30% so you have to pay 30% of the returns you are earning on FDs (around 5%) to the govt.

Effective rate of return on FDs after tax = 5% - (30% tax on total returns) =~ 3.5%

Inflation in today's date is 6-7% which means every year you are losing out on your money by around 3-4%. That is the loss in the value of your money every single year if you put it in fixed deposits which is why I would recommend that instead of fixed deposits you can choose from two alternative options :

1. Debt Mutual funds - These are the kinds of mutual funds that invest in the debt of the companies and because these are mutual funds run by large organisation and backed by very expericenced managers so the risk is significantly lesser but not 0 which is not in the case of FDs where the risks are almost NIL. Here, there is a level of risk also but because of that risk you can get better returns than fixed deposits.
2. Corporate bonds - Corporate bonds are issued directly by the company just like a fixed deposit issued by the bank. The corporate bonds are issued by the company along with stable returns within 1-3 years of horizon in which the returns are given on fixed time intervals. Wint wealth is a great option to evaluate and explore corporate bonds. Again, it's risky in the sense that it is given by a particular company and not by any govt. bank. But the good thing about say something like wint wealth, which is the platform, is that all these are secured bonds which are backed by company's assets and there is a very tedious and an in-depth evaluation of these bonds that is done at the level of the platform before it goes out to the general public.

So, these are some good alternatives to fixed deposits if you want to consider a stable income. You are free to do your own research and analysis before going for any of these instruments. The same thing is around Gold. A lot of people say Gold may not be really good because lately price of gold is almost flat and hence, most of the people are confused whether to buy gold or not. A great solution or I may say alternative to this will be the All-weather investing smallcase. All-weather investing smallcase invests in debt, gold and equity and makes it balanced in that sense because of which the returns are not very high as compared to mutual funds or stock market but the stability is awesome and if you are looking for that stability and don't want to invest only in Gold then something like All-weather investing is a great start for you from a smallcase perspective. 

This is how you should think about your portfolio

In summary, X which is your age is the most important determinant.

The 50:30:20 rule determines what's the investment amount which should be atleast 20% of your monthly income.

The 20% amount will be split into : 

1. Stable assets : Tax - saving instruments, Gold, Fixed - income instruments, Real estate (Later on)
2. High - return assets : Equity (Direct Stocks), Mutual funds, Smallcase, Cryptocurrencies

The mix will be determined by your age : 

1. 100-X goes into high return assets
2. X goes into stable assets 

When you have all of this in your hand then you understand that whatever your age is, you can start your investing journey with your own knowledge and awareness.

The worst thing that you can do is to say that, I am already late. You are not late but every single day that you do not invest is a day that you are not letting compounding take over your investments. 

I hope this blog will be useful.

Amit Sahoo, Signing off!!