Life Changing Investment Habits

Mutual fund investments can become a way of life towards wealth creation and achieving financial goals

People are often known to postpone their decision to invest for several reasons. The excuses to not invest are many – it is hard, there is too much choice, you need a lot of money to start. So you simply put it off to another day. The impact of the delay could be the difference between timely realisation of your financial goals and struggling to meet your financial goals. One of the most convenient and easy to follow investment route is through mutual funds, which in-turn invest across different asset classes taking into account risk-return suitability and factors such as investment timeframe.

The proverb, “Give a man a fish and you feed him for a day. Teach a man to fish, and you feed him for a lifetime” is very relatable to forming regular investing habits. Investing through mutual funds is a habit that can bring about a significant change to your financial life. The way the mutual fund schemes are classified allows investors to choose a fund scheme based on their investment objective as well as risk profile. While there are numerous benefits of investing in mutual funds; three aspects of mutual fund investing habits can considerably transform your life.

Being Systematic

It pays to be systematic with everything in life. The three systematic investment tools – SIP, SWP and STP (See: The Systematic Advantage) have unique advantages and offer a solution to help create long term wealth. The disciplined way of regular investment works wonders—the investor forms the habit of regular investing from an early age, and just the way a regular income is earned, uses a regular investment tool to stay invested. Take for instance investor A, who at 25 started investing through SIPs in mutual funds.

The advantage of starting early through SIPs can be best understood with A’s investment of ₹5,000 each month assuming earning 12% annualised returns till age 60 adds up to ₹3.24 crore. However, a delay of mere 5 years to start investing with same returns, works to ₹1.76 crore. So, by effectively investing ₹3 lakh less due to the 5 year delay results in a significant shortfall of ₹1.48 crore. The habit of investing through SIPs can be better understood, especially the aspect of power of compounding looking at the same example with a slight change.

Let’s say investor A starts investing ₹5,000 through SIPs at 25, but stops investing at age 50 and investor B starts investing ₹10,000 through SIPs at age 35, but till age 60 (See: The Power of Compounding). Despite investing twice the sum and for the same number of years; the two land up with different sums at age 60. In fact, investor A earns a little over a crore more than investor B. Such is the benefit from the habit of investing early and regularly.

There are two other systematic tools that come in handy when investing in mutual funds apart from SIP. Systematic Withdrawal Plans or SWP allows you to withdraw money from a mutual fund investment systematically at a regular interval. SWP in a way is the opposite of SIP and this technique could be used to re-balance your investments or for creating an income stream from your investments.

SWPs also provide a tax efficient route for regular cash flows, which could be in the form of income to be used during retirement or to supplement a pension that you may be receiving.

The last of the systematic troika; Systematic Transfer Plan (STP) is a way to automatically move your money from one fund to another. This tool can be generally used effectively when an investor is looking to cautiously transfer and invest a lump sum amount already invested in one fund, to another fund on a regular basis to help smoothen the impact of any market fluctuations.

STP could be used when you get a bonus and wish to invest it by first moving it to say a liquid fund from which transfer can be made to an equity fund. All these systematic tools can be started with small sums which can be increased over time once one understands their working.

Setting Financial Goals

All of us have several financial aspirations and goals. Many of these are for the future like retirement. But to get to that goal, we need to start investing as early as possible. To achieve financial goals easily, investors could consider investing through a goal-based approach. This method allows you to save for multiple financial objectives across various time horizons. The planning process helps you define your goals, prioritise them and determine the optimal manner for funding them.

This habit provides you the flexibility to adjust and reprioritise financial goals factoring for fluctuations in life’s circumstances and the markets (See: Goal-based investing). For instance, if you had planned to buy a sedan three years ago and were saving towards it, but with the impact of Covid-19, you may be facing a tough financial situation. You could postpone the goal completely or rework on it to buy a smaller car instead.

The goal setting process entails listing all your financial goals, putting a time line and cost to it and then working backwards to know how much you need to invest towards each goal systematically on an assumed return to achieve the financial goal. This process provides greater clarity by aligning existing assets towards each goal. Moreover, when you write down goals with timelines and values, you are more likely to develop the habit of tracking the progress of your investments towards each goal.

For instance, Investor B needs ₹20 lakh after 10 years towards college education of their child; investor B would need to invest ₹10,860 each month in a fund that has the potential to earn 8% annualised returns. Given this financial goal is non-negotiable, because unlike some other goals which can be delayed, this one cannot be because in doing so your child will lose the number of years you delay the goal. In contrast, if the same goal and sum was to build a corpus to purchase a holiday home; a few years delay in achieving the goal would not be detrimental to achieving the goal.

Saving Tax

Today, the new income tax regime allows you to do away with tax savings avenues to claim tax deductions, but for those investors who are continuing to stick to the old tax regime, they can claim up to ₹1.5 lakh deduction from taxable income under Section 80C of the Income Tax Act, 1961. With equity linked savings scheme (ELSS), you can invest in an equity mutual fund (See: Tax savings in the old tax regime) to reduce your income tax outgo as well as seek to build wealth in the long run.

Among the various tax savings avenue under Section 80C, the ELSS stands out on two distinct counts – one of the shortest lock-in of 3-years and highest equity exposure at a minimum 80%. As it is an equity mutual fund it has the potential to build wealth in the long run. The SIP facility to invest in ELSS makes it a convenient tax saving tool throughout the year than struggling to save tax towards the end of the financial year. An SIP of ₹12,500 each month will ensure that you could contribute regularly towards tax savings from the beginning of the financial year. Although SIP investing in ELSS is convenient; remember that each SIP contribution will face the lock-in of 3 years.