Investing – Emergency Fund and High Cost Debts
Investing is all about picking an asset capable of providing steady rewards according to the risk bearing capability of the investor. While saving is keeping aside a portion of earnings, investment is all about keeping a portion of the savings in a specific investment instrument for earning better return. It is essential for a person to create an emergency fund and clear high cost debts before starting investment.
Creation of emergency fund
Investment can be made only from amount that is not specifically earmarked for anything. That means investment amount or the capital for investment should be free of any obligation. From the earnings, a person is required to earmark amounts for monthly bill payments, food expenses, school fees payable, medical expenses etc. Hence, portion of earnings required for these purposes cannot be invested.
For any person to start invest, it is essential to create an emergency fund. This is required for meeting essential and emergency requirement like medical expenses. Normally, the quantum of emergency fund is approximately 4-5 times of monthly income. If you make investment out of this fund, it is likely that you may not earn sufficient return. Every time, you face an emergency, you will have to break the investment.
One of the best ways to create an emergency fund is by opening recurring deposits in banks and the best way to keep the emergency fund is in term deposits with banks. In recurring deposits, you can deposit a predetermined monthly amount for a period specified at the time of opening of account. On maturity, the principal plus interest will be returned to you. This can then be used to open fixed or term deposit with banks as this can be encashed without any hassles. It may also be noted that the bank deposits offer best liquidity and reasonable return even for short periods.
Emergency fund creation starts with savings. Experts are of the opinion that minimum 35 percent of monthly income should be set apart for saving. By sticking to the practice, an exigency fund can be created over a period. Unnecessary and lavish expenses are enemies of saving. In the initial periods of investments, with strict discipline, you will find that the happiness being derived from investment is much bigger than that derived from spending. Till the time, your financials are stabilized, present your spouse a recurring deposit as birthday gift instead of a lavish holiday package or a dinner outside.
Clearing high cost debts
In the present era of consumerism, a major portion of income of an individual goes towards credit card payments and unsecured personal loans. The interest payable on credit card loans and EMIs towards unsecured personal loans is as high as 36 per cent per annum. However, because of the easiness, individuals prefer for the same without assessing the real impact on their earnings. Often, persons opt for credit card loans and unsecured loans for investing in stocks. With a debt cost of 36 percent, any investment from such borrowing will become profitable only if the return received is above 40 per cent which is practically impossible in the present era where the financial markets are already reaching maturity. In a matured market, it is practically difficult to create unnatural returns.
So for any prudent investor, clearing high cost debt should be the first priority before starts investment.
Investment options and returns
At present, a number of investment instruments with reasonable returns are available for any investor, with varying degrees of risks. The selection of investment instrument should be based on a number of parameters like the risk profile, purpose of investment, time zone available, risk associated with the instrument etc. Investment in stock is good option for those who have high risk bearing capability and long investment horizon. Fixed income security is meant for risk averse people. Bank term deposits are best suited for short term investments with reasonable return. But always remember the underlying principle of any investment that higher the risk, higher the returns.
Return from investment
Return from investment can be of two types.
a. Periodical returns like interest or dividend
b. Capital growth
