8 MinsFebruary 24, 2020
Investments are done with the objective of wealth creation. For this, one should have a sensible and decisive investment strategy and follow discipline in investing.
In this article, we’ll focus on how young investors should strategize their investments.
Typically, young individuals display the following traits:
- Are willing to take risk
- Are in the accumulation phase of their life cycle
- Have a longer work life span
- Willing to learn with an open mind
- Positive and critical thinkers
- Confident about their future, and hold the potential to earn better income
- Own or are in the process of owning considerable assets
- Have limited liabilities and do not have many dependents to support
While these traits will hold good for youngsters, a number of them are also fast, furious, and overambitious -- which often may not be very good qualities when it comes to wealth creation. Patience and perseverance, many a time, is the key to
becoming wealthy. That’s why “time in the market” is more important than timing the market. Besides, maintaining the requisite asset allocation to each asset class---equity, debt, and gold----is the cornerstone of investing.
There are various parameters to set the asset allocation, namely: age, income & expenses, assets & liabilities, the time-to-goal (also known as investment time horizon), and your personal ability to assume the risk.
Young investors should, ideally, allocate a larger portion of their investible surplus to equity as an asset class. They should have an investment time horizon of at least 3 years while aiming for capital appreciation or wealth creation.
A broad thumb rule to follow when allocating to equities is 100 minus your current age. So, say your current age is 30 years, then 70% (100 – 30 years) of your total investment portfolio should be parked in equity, and the remaining in debt
& money market instruments and gold. Furthermore, as age increases, the allocation should gradually reduce applying the formula mentioned above.
Investing in equities
Your investments in equity can be in direct stocks or shares of companies and/or units of equity-oriented mutual funds.
But if you do not know about stock picking, mutual funds are a worthwhile and potent avenue for long-term wealth creation. That said, selecting mutual funds wisely (suiting your
needs) and structuring your portfolio astutely is the key. This is because there are 10 sub-categories of equity-oriented funds viz. large-cap funds, large & mid-cap funds, mid-cap funds, small-cap funds, multi-cap funds, focused funds,
value/contra, dividend yield, sector/thematic, and ELSS (also known as tax-saving funds). Each of these has distinct characteristics defined by the capital market regulator and there are various mutual fund houses offering them.
Portfolio allocation for young investors
|Types of Mutual Funds||Indicative Allocation|
|Equity-oriented mutual funds|
|Debt funds, liquid fund/money market funds||20%|
| || |
|Gold (via Gold ETFs / Gold Savings Fund)||10%|
(Note: For illustrative purpose only)
A young investor, willing to take an aggressive approach to potentially earn a higher return on investments over the long-term, should have a higher allocation to equity-oriented funds and lower to debt-oriented funds.
Choose the right category of equity funds
Among the equity-oriented ones, you could consider one of the best small-cap funds in the category. A small-cap fund invests a minimum of 65% of its net asset in small-cap stocks, i.e. companies that 251 onwards a full market capitalisation basis.
But do note that small-cap funds are a very high-risk-high-return investment proposition as the stocks of such companies are highly volatile. This means small-cap funds tend to go from thrilling highs to dangerous lows. Hence your investment time
horizon in small-caps should be at around 8-10 years, while you aim to maximise wealth.
Similarly, one of the best mid-cap funds can be considered. Mid-cap funds invest a minimum of 65% of total assets in equity and equity-related instruments of mid-cap companies. Mid-caps are companies that rank from 101 to 250 on a full market
capitalisation basis. Like small-caps, mid-cap stocks are also highly volatile, although the risk involved is slightly lower and the growth opportunities are better. A mid-cap fund would offer you the potential to generate significant wealth
over the long run, but make sure you have an investment time horizon of around 5-7 years.
Also, consider one of the best multi-cap funds. A multi-cap invests in equity stocks of large-cap, mid-cap, and small-caps in varying proportions. Though a multi-cap fund also attracts highs risk, it allows you to tap the high return potential
of small and mid-caps and offers the stability of large-caps too. Invest in a multi-cap fund with a time horizon of around 5 years.
One of the best large-cap funds should also be a part of young investors’ equity mutual fund portfolio. A large-cap fund invests a minimum of 80% in equity & equity related instruments of large-cap companies. Large-caps are the first
100 companies on a full market capitalisation basis. A pure large-cap fund can arrest the downside risk better compared to their pure mid-cap counterparts and small-caps. If you are looking at growth and stability with exposure to blue-chips
and predominantly larger companies, while you aim to generate wealth over the long-term, this sub-category of equity fund can be apt. But make sure your investment time horizon is around 3-5 years.
Also Read [All You Need To Know About Types of Mutual Funds]
Important to diversify your portfolio
Remember, diversification is one of the basic tenets of investing. Thus ensure your investment portfolio is optimally diversified to reduce the risk involved, but not over-diversified because that does not necessarily help.
For tax planning, choose between various tax-saving avenues prudently while availing a deduction under Section 80C. Given that you are young, can afford to take the risk and have a longer time horizon, consider market-linked instruments over the
ones offering assured returns. So, typically Equity Linked Savings Scheme or ELSS (popularly known as Tax Saving Fund), Unit-
Linked Insurance Plan (ULIP), and National Pension System (NPS) among others should be a part of your tax-saving portfolio.
Also, from an asset allocation standpoint hold at least 10-15% of your entire portfolio in gold (in the form of gold ETF, gold savings fund, sovereign gold bond scheme, and/or digital gold) with a long-term investment horizon.
Gold can be looked
up to as eternal wealth, a store of value, and a lender of last resort in times of economic uncertainties.
Over and above the aforesaid market-linked investment avenues, hold some portion of your portfolio in a bank fixed deposit (FD). A bank FD will earn you a fixed rate of return, address short-term financial goals, and your liquidity needs. Likewise,
to park money to build a rainy day fund (also known as an emergency fund or a contingency fund), a bank FD is suitable. In an emergency, when need money but do not wish to liquidate the bank FD, you can take a loan against your bank FD.
Adopting a sensible approach and being disciplined will determine your investment success.
Disclaimer: This article has been authored by PersonalFN, a Mumbai based Financial Planning and Mutual Fund research firm. Axis Bank doesn't influence any views of the author in any way. Axis Bank & PersonalFN shall not be responsible for any direct / indirect loss or liability incurred by the reader for taking any financial decisions based on the contents and information. Please consult your financial advisor before making any financial decision.