Investor profile is all about knowing your preferences in investment decisions. Before you start investing, it’s important to know the type of investor you really are. More often than not, we assess our strengths and weaknesses differently. Going through a formal investment profiling would help in creating a portfolio for the long term without having to re-evaluate every now and then.
So, making an investor profile depends on various factors like risk tolerance, investment goals, investment time horizon and changing financial circumstances and needs.
To determine your investor profile, you could ask yourself a few questions that can help you self-evaluate.
▪ Goal-based profiling
This can be understood by taking your income and expenses into consideration and then evaluating your disposable income. Calculating your disposable income is important. It tells how much money you can invest every month.
Once that is evaluated, there are a couple of funds that need to maintained. They are:
o Contingency fund with at least 12 months’ expenses
o Medical emergency fund for an illness which may or may not be immediately covered by health insurance
o Child’s education fund
o Retirement fund
Tip: There is not much you can do about your fixed expenditure like EMIs or other loan repayments. However, you can take stock of your discretionary expenditure and create a headroom for investment.
▪ Investment horizon
This can be broadly classified as short-term, mid-term or long-term based on your tenure of investment.
o Short-term investments are made for immediate goals in the next three years. These investments need to be kept handy and not be prone to volatility. Thus, it needs to be kept in a cash or liquid fund for easy access. Such investments are usually done to meet regular cash flow requirement and emergencies.
o Mid-term investments can help you meet your financial goals in five to seven years. Since the tenure is not long enough, your investment can be parked in medium-term debt investments or bank fixed deposits or even balanced funds because market volatility does not affect its liquidity after three years.
o Long term investments are for more than 10 years or indefinite timeline. Thus, equity exposure can be taken for long term investment needs.
Tip: The earlier you plan for your investments, the better it is so that it can be planned well ahead and the power of compounding can really work and do wonders for your portfolio!
▪ Investment profile
Once the disposable income and the investment horizon is known, the very objective of the investment needs to be ascertained. To determine an individual’s investment profile, his risk capacity, appetite and tolerance need to be known.
✓ Risk tolerance is the amount of risk you can take in your investment portfolio without losing your sleep over the volatility of the portfolio
✓ Risk capacity is the amount of risk you can afford to take so that your financial goals are not jeopardised.
✓ Risk appetite is the amount of risk you need to take in order to fulfill your financial goals.
The combination of all three (as depicted in the picture) is the risk profile of the individual.
Tip: You need to determine your risk-taking capacity and investment objective together so that you can maximize returns on your investment portfolio without taking too much risk exposure.
▪ Investment experience
If one has a considerable experience in investing, his risk-taking capacity is more accurately determined than others since he knows what is expected from each investment. For new investors, it is inevitable that a new investment option needs to be explored bone-deep before taking the plunge.
Tip: Age is often synonymous with lesser risk since time horizon is low.
▪ Asset allocation
Asset allocation is all about choosing an investment strategy and products based on your risk appetite.
Please note that it’s important to review your asset allocation once a year as it can change with time due to change in your investment goal and risk tolerance.
Tip: Equity is healthy and good for your portfolio but so is debt. A mix of the two blended with your investment objective and horizon can be ideal. So, monitor your ideal asset allocation at all times, irrespective of the market situations and you will see a marked difference in your overall portfolio.
In order to excel in your investments, you need to be completely honest in your evaluation of your investor profile. Self-evaluation can be quite tricky at times and thus professional help can help you define your financial goals. You need to assess your investment needs and then design an investment strategy more appropriately.
Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.
Why plan taxes before investing
We read in the previous section that tax planning can help you save a lot of money. But tax planning can be truly efficient if it’s undertaken before investing and not after—a mistake that many make. Only then can you enhance your ‘real return’ and ‘post-tax yield’—your returns after being adjusted for inflation and tax. Of course, while taxes shouldn’t drive your investment decisions, it is important that you consider it before investing. Let’s understand why: 1) Tax planning helps you understand tax exemptions, deductionsInvestments have different tax angles. Notable are tax exemptions and deductions. And before you take an investment decision, it’s important that you know about these. This can help you make a better, more tax-efficient decision. Tax ExemptionsAs you may know, not all income is taxed. The same applies to investments too. For example, the interest payments from Fixed Deposits are taxable as per your Income Tax slab rate. But dividends from Mutual Funds or Insurance payouts are exempt from tax—they attract zero tax. And while you may report them in your Income Tax filing, they don’t get added to your taxable income. Every investment option has its own tax rules. If you get your tax planning done in advance, you will know what investments fit you the best from a tax point of view. This can mean the difference between high tax liabilities and tax savings. Tax DeductionsMany confuse exemptions with deductions. In truth, they can’t be any different. Exemptions, as we read earlier, are when the income is not taxed at all. Deductions, in contrast, is an expense that lowers your taxable income, thus reducing tax liability. Now deductions can be expenses of all kinds—towards assets, investments, etc. The most notable tax deductions in India are the investments under Section 80 of the Income Tax Act. If planned wisely, these can be used for maximum benefit.i. U/S 80C: Investments like Tax-saving Mutual Funds (ELSS), 5-year Bank/Post Office Fixed Deposits, Public Provident Fund (PPF), Employee Provident Fund (EPF), National Savings Certificate (NSC), etc. can help you get a tax deduction of up to Rs 1.5 lakh every year. Your expenses towards Life Insurance and Home loan repayment too can get you a tax deduction of Rs 1.5 lakh under this section. ii. U/S 80D: All premium paid towards medical insurance can get you an additional tax deduction of up to Rs 60,000 in a year. This amount, however, includes the premium paid for policies that cover you, your spouse, dependent children and parents. iii. NPS: Contribution to the National Pension Scheme or NPS can get you an extra tax deduction of Rs 50,000 over and above the Section 80C limit.iv. Home Loan: Under Section 80C, you availed a tax deduction on the ‘principle repayment’ of your home loan. You can get an additional tax deduction of up to Rs 2 lakh on the ‘interest repayment’ of your home loan as per Section 24 of the Income Tax Act. First time buyers can get an extra deduction of Rs 50,000. 2) Even when taxed, some investments are more tax efficient than othersInvestments can be taxed or get you exemptions/deductions at three levels – the initial investment, regular interest or dividends generated throughout the tenure of the investment and the final stage—when you sell the investment to pocket profits. So, when you consider an investment, look at all three tax points. Some investments, for example, have an EEE tax policy. This is when it is tax-free at all three stages. Stock market investments are an example of such investments (if you hold it after 1 year). It does not get you an initial tax deduction, yet, when taxed, it turns out to be more tax efficient. 3) The tax-efficiency of an investment depends on the tax bracket you fall in It’s not just about how the investment will be taxed. What also matters is the tax bracket you fall in. Imagine if there are two investment options that give you equal returns. But one is taxed as per your Income Tax slab rate. The other has a fixed tax rate of 20%. In such a case, two people can make opposite decisions. Someone in the 10% tax slab would choose the first option. After all, the slab rate is lower than the 20% tax rate. But a high-networth investor (HNI) may opt for the second option. After all, for the HNI, the 20% tax rate will be welcome. This is why the post-tax yield varies for investors considerably even though the amounts invested, tenure and the products might be the same! Other important points to note about Investments and Taxes:- You may need secondary sources of income. Investments can be one of the sources. In such cases, it’s important to know your tax liability first. Income from your investments are not always taxed equally. For example, if you invest in a bond directly, then you may be taxed for the interest payments. But if you do so via a Debt Fund, the income you receive through dividends are not taxed in the hands of the investor. - How long you plan to invest also has tax repercussions. This is because tax rates differ as per holding periods too. For example, if you invest in stocks and sell before a year, then you have to pay a 15% tax. But if you sell after a year—even if it is the 366th day—then you pay zero tax. - You may already be getting enough tax deductions. In such cases, you choose investments on different parameters. But you need to know about your tax status in advance. A 5-Step approach to building an efficient investment portfolio through tax planning Step 1:Consider your income, the various tax allowances and exemptions that you can avail so that your gross taxable income and tax liability is reduced. Step 2:Choose expenses and investment products that can get you a tax deduction under: a. 80C (ELSS, EPF, PPF, Life Insurance premium, Bank FDs, NSC, etc.)b. 80D (health insurance)c. 24 (Home Loan interest repayment)d. 80CCD(1B) (additional Rs 50,000 deduction through NPS)Step 3:Consider taxation at the time of maturity, sale or redemption. Then, choose the investment with the least tax liability.Step 4:Hold on to investments for longer tenure to avail extra tax benefits. For example:• Real estate: Hold on for over 2 years to get indexation benefit. You can then purchase 54EC bonds for Rs 50 lakh to reinvest your profits and reduce tax further.• Debt Funds: Redeem after 3 years to get indexation benefit. You then get taxed at 20%. If you sell before 3 years, then you will be taxed as per your Income Tax slab rate.Step 5:Offset capital losses against capital gains from the same type of investment. A last wordMeaningful tax planning can create a significant difference to your investment corpus in the longer run.
What is a ‘good’ return on your investment?
‘Return’ is the first word that comes to mind whenever you hear about an investment option. Return is the measure of performance and efficiency of an investment option. Everyone wants an investment with a better return potential but with underlying risk associated with the same. Every investment gives return in different ways. Savings and bonds give return in the way of interest. Stocks and mutual funds pay out dividends. Instruments like stocks, bonds, mutual funds and ETFs also appreciate in value and provide capital gains when sold.What is a ‘good’ return on your investment?Everyone wants to get good returns. What is good to one may not be good enough for another. Categorization of good and not-so-good returns are derived from comparative analysis. Returns of various products are compared in consideration with features, time horizon and investor portfolio.- Benchmark performance:For example, mutual funds are compared based on their previous performances and their benchmarks. If a mutual fund is able to derive a sustainable and good alpha, i.e. performance over its benchmark, while keeping the beta (risk) low, then it is a “good” return. A benchmark is a standard set against a mutual fund so that it can be measured. Since 2012, SEBI has mandated mutual fund houses to have a benchmark to measure its relative performance. For example, if the Sensex has given a return of 12.65% in the last three months and a particular mutual fund has given 14.75% annualised return, then the relative performance is 2.1% more than its benchmark.- Past performance:Previous performance is often considered while making future investment decisions. It may not be the all-important feature, but you should give it a look before opting for a specific fund.- Consistent Returns:Some say that penny stocks can provide “good” return. But so is gambling -- if you get lucky. But what if you don’t? That’s where “good” investments come into play. “Good” return is consistent returns over a longer tenure. Not just returns!Returns are surely important but it is not the only factor that needs to be considered. Higher the return expectation, higher the risk. So, if you are not too keen on taking too much risk in your investment portfolio, then you would have to settle for lower returns and vice versa. If you need high returns, you must accept the volatility of your investment portfolio.However, if you have time on your side, you can opt for high returns without risking your portfolio since the time horizon eases out market fluctuations. So, to generate a good return, it makes most sense to consider all the following points of investing fundamentals mentioned below.✓ Selection of right investments based on one’s risk appetite, investment goals and asset allocation✓ Understanding before investing ✓ Having a long-term perspective for investment goals fulfilment✓ Diversification of investment portfolio ConclusionReturns are important but it is not the be all and end all of investments. It is more important to stay disciplined because it can help you to achieve your financial goals Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.
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