Looking to invest in mutual funds? Answer these four important questions first

The first step towards investing begins by knowing about your overall financial condition. It is critical to develop a clarity with respect to the current level of income, assets, expenditure, liabilities, and savings.

Ultimately, your success in investing depends greatly on your ability to save. An increase in savings will gradually encourage you to invest more. Thus, monitoring expenses closely becomes a key to boost the level of savings.

Consider putting a cap on how much you want to spend and then stick to it, then immediately invest what is left behind. Make sure you have some money kept away for emergencies though.

The liabilities which you have created till now might be stopping you from saving. Piled up credit card debt happens to be the biggest reason which may eat up a major chunk of your salary. Thus, it is very important to clear your outstanding credit card bills in full before thinking about more expenses or savings.

Once you are done with it, look into the risk cover aspect. You may buy a health cover for yourself and your family members. In case you are shouldering long-term loans like home loans, then buying a term insurance cover would secure the financial future of your dependents. Lastly, ensure that you have created an emergency fund to meet unforeseen expenses of at least six months. All this will help you to avoid digressions and shocks coming in the path of investing.

Investing should not be made in a random manner. You need to ask these questions to ensure you get the expected results:

1. What are my financial goals?

It is rightly said that if you don’t know where to go, then it doesn’t matter which path you take. A similar thing happens with investing as well. Goal-oriented investing is always superior as compared to unplanned investing. Financial goals relate to the objectives which you want to achieve via investing. This highlights the priorities wherein you need to channelise your resources and accordingly save money for them.

When you plan in advance, then you can ascertain which goals are more important than others. This has to be done because of resource constraints in the backdrop of unlimited goals. It also helps to resolve the conflict which may be happening during resource allocation towards goals. In absence of goals, you may end up spending all your money in non-important things.

2. How much risk can I digest?

All kinds of investing come with a certain amount of risk; the only difference being that some financial instruments are riskier than others. If you are planning to create wealth by investing, then you need to be game for the inherent risk. It is because wealth accumulation is the function of compounding and for that to happen your money needs to stay invested for the specific period.

If you invest in say equity funds without knowing about your risk tolerance, then you are definitely going to pull out the money even at the slightest variation in the fund value. It will ultimately prevent your money from compounding the way it should have been. Moreover, in case you exit at the wrong time, then you may end up in a cycle of buy high-sell low.

The point here is not to be apprehensive and avoid risk, instead, you need to diversify the risk to increase your chances of successful investing. It is possible when you know that whether you are a conservative investor or aggressive investor and select the products prudently. The aim is not to put all your eggs in one basket but to construct a well-diversified portfolio comprising of various asset classes.

3. How long am I planning to stay invested?

Your length of investing is reflected in your investment horizon. It is used to describe the time period for which an investor is planning to stay invested in a financial instrument without feeling the need to redeem/exit. Investment horizon depends on your goals and on the product chosen for investment.

If you want to earn a higher rate of return, say in the range of 12%-15, then equity funds tend to be the suitable vehicle. Equities require the investor to have a long-term horizon and take a relatively higher risk.

Conversely, a goal to create an emergency fund is a much immediate one wherein you need money at short notice. Here the preferred product may be a liquid fund which gives you moderate returns at high flexibility to withdraw funds when you need it.

From this context, investment horizon can be short-term (6 months-1 year), medium-term (up to 5 years) and long-term (more than 5 years). Based on your investment horizon, you may decide a lot many things like which investment should be chosen, which ones to avoid and how long you need to hold the investment before selling.

4. What is my initial capital investment?

Once you are clear about your goals, risk tolerance and horizon, determining the initial investment becomes pretty simple. All you need is to use financial calculators which can be easily found online. Start with determining the amount required to meet a goal.

Consider a medium-term goal like an exotic vacation which would cost around say Rs 5 lakh. If you invest in a debt fund which gives you a return of around 10%, then you would have to make a monthly SIP of around Rs 6456 to accumulate Rs 5 lakh in 5 years. Your SIP contribution will increase/decrease depending on the rate of return and investment horizon. Remember that in order to get higher returns you need to take higher risks and pursue a long-term horizon.