Before enjoying ourselves in selfish abandonment, we will want to accumulate enough financial resources to ensure that we never become a burden to others.
We are all so fortunate that our Swamiji has great passion to share his personal formula for building wealth, which is designed to eventually create a lifetime income stream.
While the topic of investment management is vast and often technical, Swamiji, like no other, has simplified the fundamentals to give us a solid foundation upon which to build.
This informative article includes everything you need to know to get yourself started.
In a nutshell, your investment strategy boils down to four key factors:
1) Your Financial Goals
2) Your Budget and Financial Plan
3) Your Desired Return and Time Horizon
4) Your Tolerance for Risk
Financial Goals: Don’t Start Investing Without Them
How much financial resources do you need to live now and in the future?
In Sanskrit, the word “Artha” means the resources that we need to achieve our goals.
Once we have defined our goals, we strive to acquire and budget the use of resources necessary to achieve them.
Our Swamiji, in one of his talks, spoke of his years as a wandering sadhu. Artha for Him was the dress that he wore and the kamandulu (water pot) that he carried to perform His puja.
Artha for the student would be his books, clothes, and the money needed to pay tuition.
A married adult or community leader would define artha not just for his own personal goals, but also for those of his or her family and community members.
How do you define your artha? What resources do you need to achieve your goals?
However you define it, required resources are clearly dependent on the goals that we set for ourselves.
As these goals are unique for each individual, and vary with the different stages in life, it is time well spent for you to write them down and review them often.
Once our goals are understood, then we strive to get there with the least possible effort.
The word “sadhu” means one who is efficient. So, we strive for the highest and the best through efficient actions which waste no time and effort.
Turn Your Efforts Into Profit with a Financial Budget
To achieve our highest and best, we should answer the following questions:
• How much money will we need and by when? To effectively answer this essential question, we need to develop a financial budget which projects our expenditures over the next 5, 10, or 15 years.
Many of you have a budget, but if not, a great resource can be found in the article Balance Your Life with 4 Easy Budgeting Steps (Steps 1 and 2).
As we make our budgets, let us discriminate as to what we really need to achieve our goals, as distinguished from what might be “nice to have.”
Let’s delay those “nice to have” desires that might be extravagant until we have more discretionary income.
Certainly we will want to renounce whatever will take us farther away from our goals. In this way we can arrive at the optimal amount of resources that we may need in the most efficient way.
• How much will we be able to save and how often? To decide how much we can save, compare our current income and our future income with our expected outflows. Balance Your Life with 4 Easy Budgeting Steps, Steps 3 and 4 provides an excellent road map. With a surplus of net income, you can develop an Investment Strategy. With a deficit, review your budget to see where expenses can be reduced.
Our savings can be increased through investing it and earning a return on that investment. The approach we use is to allocate the savings to a variety of asset classes (stocks, bonds, money market accounts, real estate, cash, etc.), so that the money saved can generate a return.
Through discipline and time, the combined returns in the form of interest payments, dividends, gains on stock and real estate values will allow the money to work for us to help us achieve our savings goals.
As more of our savings works for us, we can hope that one day the various investments will generate sufficient income so that we no longer need to work for money. The money works for us.
The first aspect in developing a sound investment strategy is defining the rate of return that we desire from our investments.
In the previous section (Set Your Budget and Financial Plan), we have defined two things:
a) How much we will need to achieve our goal and by when
b) How much money we can invest initially and how much we can contribute on a regular basis
These two pieces of critical information will define what kind of return from the investments is required to reach our goal.
The “Rule of 72” is an easy way to estimate what rate of return is needed to double an investment‘s value over a certain time period. Just divide 72 by the number of years desired for doubling the investment gives the approximate rate of return needed – check out this simple formula:
For example, if you want to grow $25,000 to $50,000 in six years, divide 72 by 6 to find that you would need an average annual rate of return of about 12 percent.
By reversing the rule, you can find out how long an investment will take to double based on the rate of return you receive currently.
If an investment is earning 8 percent annually, dividing 8 into 72 tells you it will take about nine years to double your money:
For more sophisticated calculations, there are a number of calculators available online, or even financial calculators for purchase (Editor’s Favorite: HP 12c Business Calculator) which determine the rate of return required to reach a defined goal in a specified period of time.
The Power of Compounding, which means we allow the earnings from our investment to be reinvested, will increase our savings dramatically, particularly if you are early in age where you have the added advantage of time. Here’s the formula:
Below is a simple example of the effect of compounding. Suppose we invest $100,000 for thirty years. Consider the difference between a 5 percent rate of return and an 8 percent rate of return, both compounded annually: a difference of only 3 percent.
At 5%, $100,000 grows to $432,000 in thirty years.
Look what happens at 8%! That same $100,000 turns into $1,006,000 in thirty years!
In this particular example, we see that by increasing our rate of return by 3% we have more than doubled our savings. But, there is another important concept — the value of TIME!
On the chart above, if we held for 20 years it would accumulate to $466 K. In other words, by investing the additional ten years (from 20 years to 30 years) we accumulate $540 K! This demonstrates the value of time.
In summary, to achieve our required return, we need both time and an understanding of the trading fundamentals to invest in assets which will generate our expected return.
The financial world offers several types of investment vehicles (stocks, bonds, real estate, cash, etc.).
These investment vehicles, or asset classes, have different risk levels. So, before we can figure out how much to invest in each, we need to understand risk.
This is the next important step on our journey of developing an efficient investment strategy.
Avoid Costly Mistakes Through Risk Management
Risk is the possibility that the investment may not perform as expected and could actually lose a significant amount of the original invested capital.
In general, when we desire higher returns from our investments, we must accept a higher risk of losing money.
Risk and reward have a direct correlation; the more risk (potential loss) you are willing to take, the more reward (potential return) you are likely to receive. Less risk usually means less reward.
For example, highly liquid assets, like a checking or money market account, commonly have low rates of return with little risk.
Likewise, an investment in the stock of a new start-up company could yield big profits, but there is also the risk that you lose your entire investment!
In another example, you could choose between a conservative bond fund (less risky) and an aggressive growth fund (more risky).
You will expect a greater return from the aggressive growth fund, but you are taking on more risk (i.e., there is a higher likelihood of losing the measurable portion of your investment). You may earn a greater reward, but you could also lose on the trade.
Our goal in managing our investments is to try to get the highest return at the lowest risk. But every person’s risk tolerance is different.
How much risk are we willing to accept? The answer to this important question depends on your personal situation.
Where are you right now in terms of life phase and what are your personal objectives?
For example, are you in college with tuition bills?
Are you trying to save for a home?
Do you have a new born baby?
Are you retired?
There are many ways to determine our level of acceptable risk based on our life situations.
The table below helps you think through your risk levels for your particular life situation.
These criteria will serve as aids as we formulate our goals:
There are ways to reduce some of our risk through asset diversification.
When we diversify our portfolio, we allocate our resources across several investments and investment classes (as opposed to very few investments and investment classes).
In doing so, we reduce our overall risk substantially. When we diversify, if one investment becomes unprofitable, we do not have all our eggs in one basket, and all is not lost. This enables us to generate the most efficient return according to our tolerance for risk.
Risk is also inversely related to liquidity. Liquidity is how easily and quickly money can be accessed at full value and without penalty. Highly liquid assets, like a checking or money market account, commonly have low rates of return but are less risky.
As each investment vehicle is unique, before turning to formulating an investment strategy, we need to be aware of the different vehicles which are available in the market: asset classes.
Asset Classes represent the broad categories of investment vehicles. Each asset class is unique in its risk and reward profile.
It is our goal to combine these asset classes in such a way that the returns achieve our goals with the least amount of risk.
There are several ways of defining the various asset classes. Many brokerage firms define them as: Large Cap Equity; Small Cap Equity; International Equity; Fixed Income; Cash Investments; Other. These are all instruments you can purchase through a Brokerage firm.
Each asset class can be sub-divided into a number of Sectors, which distinguish the basic areas of economic activity.
Each Sector is divided into a number of Industries, and each Industry has unique characteristics, which apply to the companies within that industry.
Cash is intrinsic to them all, so it is a part of every Sector and every Industry. Because it is a more technical subject, we will discuss Sectors and Industries in our next article.
Because there are a large number of investment types available, it is important to understand how each works so you know which ones to use to help you reach your goals.
Investment Strategies Designed to Multiply Your Income
Now that we know that we have to allocate our savings across multiple assets and asset classes to maximize our return and minimize our risk, let us turn to specific advice to carry out our investment plan.
Our overall investment strategy can be defined when we are clear about our risk tolerance, liquidity preferences, and expected return. Our time horizon and financial goals are also important determinants of your strategy. Obviously, the longer our time horizon, the more aggressive our allocation can be.
This is where financial consultancy services can be beneficial, in making sure we have a clear definition of our goals and time horizons, and a proper allocation to the various asset classes so as to diversify risk, maximize reward, and to free ourselves to the extent possible from the emotional roller coaster of chasing greed and trying to avoid fear.
Certain strategies are designed specifically for certain types of goals. Here are some common goals with their typical strategies:
Goal 1: Establish an Emergency Fund
The requirements of an emergency fund (low risk, high liquidity, low return) can be met using investments like a short-term certificate of deposit (CD) or money market account.
Goal 2: Accumulate Long Term Savings
If the goal is longer term (less liquidity needed) and can be reached with average market returns (moderate reward), then exchange-traded funds (ETFs) or a portfolio of diversified mutual funds might be the answer, because both are investments that typically have moderate risk.
Goal 3: Achieve Growth with Access to Near-Term Cash
If the goal requires a more aggressive approach (higher returns with some liquidity), then an actively traded stock portfolio (more risk) or options (a leveraged trading strategy that entails even greater risk) might be the answer. Leveraged strategies generally increase both reward and risk.
There are numerous strategies to fit different goals. In all of them, we need to consider different allocations for the different funds that we may need.
For example, in our discussion on budgets, we decided we might need a rainy day account, an intermediate term contingency fund, a catastrophic insurance fund, a capital expenditure fund (like a down payment for a new car or new house), and a retirement fund. Each fund has a different objective and time horizon. So the strategy for each is unique.
These unique various fund accounts can be matched to a variety of different Investment Profiles. Below are investment profiles which proportion your savings into asset classes according to strategies and their achieved returns in the past.
Simply match your goals in each fund to an allocation strategy (from the Investor Profile Table). Here are some examples of how you could invest in various funds:
Rainy Day Fund – Short-Term (under three years)
Intermediate-Term Contingency Fund – Conservative (3-5 years)
Catastrophic Insurance Fund – Moderate Conservative (around 5 years)
Capital Expenditure Fund – Moderate (around 10 years)
Retirement Fund – Aggressive or Moderate Aggressive (10 – 15 years)
Investor Profile Tables
The average annual return ranges from 6.6% for the Short Term Allocation to 10% for the Aggressive Allocation. The best year for the Short Term was 19.8%, while the best year for the Aggressive Allocation was 39.9%.
Deciding on Portfolio Allocation to Stocks
As a rough estimate of asset allocation, many professionals recommend that you subtract your age from 100 to determine the percentage of stocks in your portfolio. However, this guideline does not take into account your marital status, health, and other critical factors and may not be appropriate for your specific situation. Consider the following information to make a more informed asset allocation choice:
* This means you are borrowing to fund purchase of stocks
Take Yourself to the Next Level – Act Now!
Ready! Aim! Focus!
It is time to take action and implement your Plan!
You have done all the preparation work. You know your goals, you’ve defined your budget, you’ve identified the funding alternatives and their associated risks. You have even developed a trading strategy.
Many investors find that writing down all details, from how the goal was determined, to the rules they will use for trading or investing, is very helpful. A checklist outlining each step to take to put the plan into action is beneficial, as well.
As you begin investing, keep in mind that good investors are disciplined investors. They focus with one-pointed concentration on their objectives. They stay disciplined, follow their plan, and steer clear of the Ten Most Common Trading Mistakes.
The time and effort that goes into this process so far has laid a great foundation for your future. It is our hope that that you will apply the same level of effort in implementing your investment plan.
May God Bless you in your journey toward personal fulfillment.
Jai Maa! Jai Swamiji!