This article was published in Live Mint on 11 Sep 2016
The complication starts when people do not understand the difference between ‘saving’ and ‘investment’; most people use these two words interchangeably
In my experience of 25 years in banking and insurance sectors, I have had the privilege to look closely at how people manage their money and understand the reasons behind their behaviour. The one basic truth about money that I have understood is this: keep money matters simple. Then, why do a large majority of people mess up their personal finances? What can we learn from them so we stay on the right track ourselves?
Let me tell you about some common mistakes that people make without realising. I met a company’s managing director in Gurgaon, aged 51 years. Let’s call him A. A is an extremely successful professional in his field and has risen to the top of his large multi-national company. A has all kinds of relationship-managers from the bank, giving him wealth advice. Therefore, I was really taken aback when we discussed his retirement plan. He wanted to retire at 55. He has accumulated 30 different mutual funds and stocks and a couple of properties ear-marked for his retirement corpus. There was simply no debt portion to his retirement kitty. When I mentioned that after paying for the property loan interest, his properties in Gurgaon would yield him a loss, he was shocked. With all his money in volatile investments, we were not sure what exact amount he would have in hand when he turns 55. I can actually understand why A is where he is. He has a busy work life, with extensive travel, and does not have the time to sit and think about his money matters. Therefore, he made ad-hoc decisions based on what his peers and colleagues did, and what his bank managers told him to do. Despite earning very well, he did not channel his savings through the right vehicle for his goal of creating a large retirement corpus.
The complication starts when people do not understand the difference between ‘saving’ and ‘investment’. Most people use these two words interchangeably. Saving is for your essential goals such as retirement. Essential goals are a must-do. There is no choice but to accumulate that corpus. While saving, it is important to ensure that the corpus is available with some certainty for your goal, when you need it. The returns matter less. On the other hand, investment is the next step in your wealth-creation journey, after you have achieved your savings goals. If you have surplus left over, then you should look to get handsome returns to grow your wealth. A did not save first for his safe retirement corpus, but went ahead and invested for growth instead. That is why despite working till 51, he is not assured of a definite corpus for his retirement.
I know a doctor couple, who run their successful medical practice in Mumbai. They pride themselves on how to make money from shares. They both have faith in their share broker who gives them good tips. When we looked at their portfolio, we found there were 35 stocks that had very small amount of investments. This just clutters up the portfolio and adds no value. I am not even sure whether they understand the fundamentals of all the stocks they own, or if they simply got enamoured by the returns these stocks had generated in the past. Over the last 10 years, whenever there was a ‘buzz’ around a stock or an industry, their broker asked them to pick it up. They never sold anything, as they did not need the money. This, I understand, can happen to all of us. We drift along and accumulate stuff as we go through life.
These are real people like you and me. The problem is, when it comes to money we let the market noise drown out our common-sense.
If you identify with the above examples, consider doing the following:
Here is a simple retirement plan for everyone: Save regularly in Employees’ Provident Fund (EPF), Public Provident Fund (PPF) and National Pension System (NPS) and that should be sufficient for most people to accumulate their retirement corpus. Add some tax-free bonds, debt bonds and equity funds and the picture would look pretty.
My suggestion to A was to sell a large portion of his shares, the aggressive equity funds and the property; and create a fixed-income portfolio (fixed deposits and bond funds). This is work in progress.
My suggestion to the doctor couple was to sell all of their small stocks and only keep 10 stocks that were solid in terms of performance and significant in terms of money invested.
If you are starting with your professional career and saving money, it would do good if you steered clear of these mistakes and just kept it simple.