How to plan your finances and invest money in India in your 20s – A detailed step

by step guide

A complete transcript of the podcast is published below if you prefer to read

rather than listen.

Transcript of the entire podcast

So the first post of 2017 is one that I have been meaning to write for 10 years
now. It is the one thing on which I have advised countless people for over a decade
now. This list of people including CEOs, business consultants, young entrepreneurs
and even some of my financial advisors. I do not claim that this is the best or the
only way to invest – simply that this is how I am investing and how I would advise
anybody who asks me for advice to invest. The rest is up to you.

First things first, Why I am qualified to write this?

I began my career with one of India’s best wealth management outfits in 2001. I’ve
seen the ups and downs of pretty much every one of the last few cycles in India –
the don’t touch stocks period after the 2000 crash, the India will rule the world
period from 2003 to 2008, the great financial crash of 2008 (I was actually sitting
in the Lehman office in NYC when Lehman imploded) and the rejuvenation of markets
from 2011 to 2016. There’s no investment scam that I haven’t seen and no get-rich-
quick idea I haven’t evaluated (both wrongly and rightly). I’ve started my own
company and sold it. I’ve traded public equity stocks in the stock market and now
invest in private companies for a living. Most importantly, I’ve made some decent
investments through this period and have a decent track record. So if you find the
financial world too complicated, maybe this series would be of help to you.

Simply put, I began my career in 2000 and quit my job in 2011. From 2011, I ran my
own company for 5 years during which period I invested into the business and did
not withdraw a single paisa from the business till I sold it in 2016. So basically,
in 10 years of working, I managed to save enough to retire comfortably and
maintain a good lifestyle for myself and my family – and we still did everything we
did when I was working as when I was a “poor” entrepreneur. To me, that is
something that I wanted to be able to do since the day I began my career. If that
is something that works for you, please feel free to follow this list. If it
doesn’t, contact your bank relationship manager or stock broker and he will
undoubtedly be better qualified and happier (and better remunerated) to help you.

So without much ado, here is what I do (and advice you to do). This is obviously a
slightly long post, so I will be putting it up in several parts. The whole piece
consists of 4 parts.

Know your investment amount and the horizon

Choose what to invest in
Rebalance your portfolio – or not
Know what to avoid.

Since most of my readers are super-intelligent, I will just present the quick and
dirty summary here. I will explain each of these 4 parts in detail in the next four
posts this week (for explanations and detailed reasoning on why I suggest these,
read the follow-up posts)

Knowing Your investment amount and the horizon – how much money do you have to
invest and with what horizon. How do you decide that?
Know your monthly income and expenses. Account for one-off expenses like
vacations as regular expenses and add these up over a year. Since you know what
comes into your bank account regularly, once you have understood your expenses,
this should be simple enough.
Put away 2 years of expenses in a Rainy Day Bucket. While doing this
exercise, think about your expenses and see if there are any expenses you could
reduce. Your investment mantra has to be “SPEND LESS, INVEST MORE”.
Identify significant planned expenses in the next 3-5 years of your life.
These are the usual goals and milestones that you are asked to identify by all
advisors. Children College education, Buying a house, MBA degree you yourself want
to do in a few years after saving from your current job etc.
Here is an illustration showing how to calculate this with some sample
numbers. All numbers are in Indian Rupees.
Know Investment Amount and Horizon.png
And so you now know all that you need to know in order to start picking
your investments. 1. Current Pool (Rs. 6,00,000 in example above) 2. Essential
Monthly Savings for Rainy Day and 3-5 year needs (Rs. 22,000 in the example above)
and 3. Monthly Long-Term Investment Amount (Rs. 7,000 in the example above). Once
you have established these 3 numbers, you are done and know your balance sheet well
enough. You are now ready for the next step.
Choosing what to Invest in – Provident Fund, Fixed Deposits, Mutual Funds,
Stocks, Property, Gold, Real Estate etc. There are so many options. Choosing which
investment to make is now the important decision for you to make. This is largely a
function of the time horizon you have and the kind of returns you should make. For
me, I keep this reasonably simple. I shall explain what I do below.
Fixed income for the Rainy Day Bucket. This is important. You cannot afford
to take any risk on this amount since you will not have the time to recover in case
you do make a loss on these investments. Hence this investment amount has to be
kept in the safest and easily accessible investments. Historically, this used to be
simple – you just had Fixed Deposits to do this. Nowadays, there are a few more
options, especially liquid funds for money that you might need any given day.
You can put about 50% of this money in Fixed Deposits with reputable
banks (avoid co-operative banks and stick to the largest, safest banks here). Try
and match the duration of the Fixed Deposits with your known expenses (In the
example above, you could choose 3-year fixed deposits to match the MBA need).
For the balance 50% of the money that you could require any given day,
put it into a category of Mutual Funds called Liquid Funds. Liquid Funds are safe
and almost guaranteed to not be negative on any given day. Choose liquid funds from
any reputable mutual fund house for this – Franklin Templeton, ICICI, HDFC, SBI and
Reliance work for me. This money is available for you on any given day and gives
you returns that are almost similar to Fixed Deposits with greater liquidity.
Invest in PPF – the best investment in India. The PPF is simply put the
best investment you can make in India. In actual numbers from the last decade, the
PPF on the average gave you 9% returns (slightly higher than Fixed Deposits) with 3
significant benefits – PPF investments are exempt from income tax (so if you invest
1.5 lakhs in PPF you will get a tax exemption for the same in your annual income
tax), PPF investments also are exempt from income tax when you withdraw the amount
after 15 years and the returns are also exempted from income tax. These three
benefits (EEE status) basically mean that you are earning a risk-free rate of
around 11%-13% (depending on the tax bracket you fall in). This is almost equal to
the long-term return of stocks (or any other investment option in India). The only
catch is that there is a limit on this investment. You cannot withdraw it before
you complete 15 years and you cannot invest more than 1.5 lakhs per person in this
scheme. Here is how you should invest in this particular investment on a step-by-
step basis.
Maximise your PPF investment to the limit possible. Fill up the 1.5
lakhs per year limit for all your family members (this includes minors). Until you
exhaust this PPF limit, do not even look at anything else
If you have a daughter, maximise the Sukanya Samriddhi scheme
investment also (same as PPF with similar limits and benefits but only available in
the name of a girl child if you have one).
For a family of 2 parents and a kid, this limit basically becomes 1.5
lakhs x 3 = 4.5 lakhs a year. If the kid happens to be a daughter, then the total
limit rises to 6 lakhs per year. Until you have exhausted this 6 lakhs per year
limit, do not even look at anything else.
Most importantly, almost no advisor recommends this because it does not
give much incentive to distribute PPF (no fat commissions). So you will have to do
this for yourself. Go ahead and max out your PPF investments. You can do this
through any bank or through the post office. I find it simplest to do this through
my mobile banking app.
Buy a medical insurance and term insurance to cover your life. Life is
uncertain. Plan to save your family from any such uncertainty. Buy a simple term
insurance from a reputed insurer (my personal preference is ICICI). The sum assured
should be about 20 times your annual salary to ensure that your family is not at
all impacted by anything that happens to you. In addition to this, buy a medical
insurance to cover any unplanned medical expenses. Again, my preferred insurer is
ICICI Lombard (they have great customer service) but you can choose any other
insurer that you are comfortable with. If it helps, understand that IRDA (the
Insurance Regulator for India) has made rules that make it virtually impossible for
any insurer to go bankrupt. So, your choice of an insurer should just be one that
covers the hospital that you usually go to. Enough said on this topic. Actually no,
one last thing. DO NOT BUY A ULIP or any other insurance linked product. Buy a
simple term insurance and a simple medical insurance. For investments, buy
investment products. More on this in later posts, but that is all you need to know.
Buy a house once you are settled (and buy only one house) On this one, the
simple advice I have is – buy a house where you will eventually settle down. And
buy a house that is a little bit of a stretch in terms of expense as well as size.
Account for your family and lifestyle (as well as your income) to grow and then go
for it. And lastly, buy only one house.
Why stretch yourself? Because it is very very difficult to buy and sell
a house. Apart from the very high costs, brokerage, taxes etc, it is such a high-
value investment that you will not be able to manage the cost of two houses if you
upgrade (unlike say a mobile phone or a car where you can buy another and sell the
first later). Moreover, every time you buy or sell a house, you will also spend a
considerable amount on doing up the new place. So buy once and buy something that
will last you a lifetime. If you cannot afford it, wait until you can and then buy
something that works.
Why buy only one house? Houses are illiquid and not particularly good
investments over a complete cycle. Unless you are buying them when rental yields
are comparable to EMIs (and it happens frequently like between 2000-2004 India or
between 2009-2014 US). But for your primary house, you don’t need to worry about
yields and prices and complicated things like that. Just buy something that works
for you for a considerable time and which you can afford.
To summarise, buy a house you can grow old in as soon as you are
settled enough to know that you will grow old in a particular place or job and can
afford it. The typical rule of thumb is to buy it with 3-5 years salary. This rule
of thumb is based on simple logic. No matter what happens, you have 2 years of a
rainy day fund. You have current visibility on your job for the next 1 to 3 years.
So no matter what happens, even if you lose your job and take 6-9 months to find a
new job, you are comfortably able to manage your EMIs. So stick to that thumb rule
and you should be in good shape. And if you end up getting promoted or making a fat
bonus in a given year, prepay your house loans a bit and reduce your outstanding
loan. The sooner you get the loan out of your system, the better for you.
One last thing about buying a house. Apart from the peace of mind that
owning a house gives and the tax break that you get for paying EMIs, there is also
the behavioural effect of forcing people to save more. I know many many people who
started forcibly saving when they had EMIs and were forced to cut down on
discretionary spending to afford their EMIs. This is a very real factor that should
not be ignored. Ideally, you should cut down on your discretionary spending even if
you do not own a house. As mentioned previously, “Spend Less, Invest More”
Buy Stocks with the rest of your money. For the rest of your investment
portfolio, my view is simple. India is one of the best investment destinations for
global investors.
Indian stocks are at a cannot-go-wrong, once in a decade kind of
investment opportunity. There, I’ve said it. Either you agree or you don’t. With
growth in most major markets severely challenged and the end of a multi-decade bull
market in bonds, there is virtually no way global investors can avoid India.Even in
India, less than 1% of the population owns stocks. Everyone has fixed deposits and
real estate portfolios. As with every developed economy, eventually, you should
expect this proportion to rise significantly. This, in essence, provides a floor to
how much markets can fall in India. The monthly SIP flows over the last few years
now have proven that Indians investing in stocks is a trend that is a structural
one. Benefit from it and get invested as soon as you can prudently is all I will
say.
You can choose how you want to do this. The simplest and can’t go wrong
approach is to do Mutual Fund SIPs. Choose 5 large-cap funds across 5 different
fund houses of repute – Franklin Templeton, ICICI, HDFC, Reliance and SBI work for
me. Pick any others that you are comfortable with. As always, don’t over-complicate
this.
If you understand the stock market at a very basic level, choose stocks
yourself. This saves you about 2%-3% a year which is about 15% of your long-term
returns of 10-15% a year on stocks. As you do this for a longer and longer time,
you will get pretty good at it.
Investing in private companies through angel investments, seed
investments, venture capital, private equity etc. Across the world, this remains
one of the most high-risk-high-return investments you can make. Since so many
people ask about this, here is my take.
If you are investing in a private business, ensure it is a
profitable small business with a person who really knows the business and is a god
in that space. Moreover, ensure that he/she is totally committed to the business.
Business is real hard and many things can go wrong in the short run. Find someone
who is in it for the long run.
Ensure you get a really good deal – significantly better than
public stocks. I know people who invest in small startups at valuations that are 3-
4 times the valuation of large listed comparable companies. That is never going to
end well
At the risk of repeating myself, ensure that there are real profits
and real revenues. You are unlikely to know the next Mark Zuckerberg or invest in
the next Facebook. Just recognise that basic fact and you will do well for
yourself.
If you are interested and would like to invest in some great,
profitable private businesses, I know this great firm that does a fantastic job of
it. Go to www.AlphaCapIndia.com if you want to know a bit more. Disclaimer, I work
here.
Look at this aspect of investing as investing in a real business
partnership with a businessman as a financial partner. Most people know how to do
this. Look for honest businessmen who need a little capital to run a business that
is already doing pretty well. This could create some great income opportunities for
you in addition to your main income stream. Do this well and it could help you
retire early.
Rebalancing your portfolio. What to sell, how to book profits, what to buy
next? The rule on this is simple. Be Lazy. Do as little as possible. If you focus
on getting your investments right the first time – and broadly right is enough,
then you don’t need to do too much.
Never rebalance your portfolio because an investment you made is up 300%
(or some such figure) and hence has become 20% of your overall portfolio. Imagine
people selling Infosys after the stock went up 100 times. They would have missed
out on another 100 times their returns. Ride your winners.
The exception to this is when you discover that a particular investment of
yours is a particularly bad investment. Say you discover that the management of a
company whose stock you own is not particularly scrupulous or the key promoter of a
company you own is in particularly bad health. Or you discover that a company has
started to take on significant levels of debt in order to grow its business that is
otherwise degrowing or becoming a lower and lower margin business. Think hard about
it but cut your losses if the basic facts about it change. And whatever happens,
avoid throwing good money after bad.
List of things to avoid like you avoid a person with an infectious cold –
sometimes I feel this list is the most important list of all since most people
understand the first 3.
The next great asset class – whatever it is. This includes all and more of
the following type of investments – bitcoin, namecoin (yes that’s a real
cryptocurrency), structured products created by your bank that are too good to be
true (and indeed they always are), agricultural commodity derivatives, range
accrual products, art funds, real estate funds and other such exotic products. As
mentioned twice previously, don’t overcomplicate your investment portfolio. Simply
put, stocks are the next great asset class for India. Stick to them.

Phew! That’s long enough already. I will take up each of these sections in more
detailed posts later in this week. For now, Happy New Year and wish you a
significantly more prosperous 2017.