Steps To Generate Wealth in 2021

Wealth creation is a gradual process that can only deliver on its promise if investors are patient and disciplined with a long-term investment horizon. With the start of a new year, we can refresh our portfolio strategy to bring it on track for future years. The steps are summarised below:

·       Determine wealth or capital available

·       Estimate future streams of income and future planned expenses

·       Check if unplanned expenses are covered with adequate insurance. Else create reserves for the same on the lines of an emergency fund

Investors will have a clearer idea of the capital available for investments. Further, there are three different investment approaches that investors can choose from:

1. Asset Allocation Approach: This is the classical way to generate wealth. It prioritises diversification and discipline as the most essential ingredients to build a successful portfolio. Simply put, investors are inherently either high-risk takers or low-risk takers. One should avoid flip-flopping between the two – from a high-risk portfolio to a low-risk portfolio or vice-versa based on market returns in the past or basis expectations of the future. Thus, it is advisable that investors choose which risk profile (high or low) suits them well and then stick to that profile. Besides, ensure that the following hygiene checks are in place:

- Allocate across equities, fixed income, alternate assets to diversify investments

- Pick 4-6 high-quality fund managers to diversify your portfolio

- Take investment advisors’ help to select the right fund managers

- Do not over diversify or over concentrate one’s portfolio

- Let equities chase returns while fixed income provide safety to the portfolio

- Keep an eye on total costs

2. Capital Protection Approach: Prioritises the need for protecting capital. Only excess returns are invested in riskier investments for higher returns:

- Investors can choose excess returns in the following ways:

i. Excess returns: All returns earned on the capital invested in low risk fixed

income instruments

ii. Excess returns: Only returns earned over inflation in a particular year

Example:

An investor starts with Rs 10 lakh as initial capital and earns 6% interest on

a fixed deposit. Let’s assume 4% to be the rate of inflation in that year.

The excess return in each case will be as follows:

i. Excess return: 6% x Rs 10 lakh = Rs 60,000

ii. Excess return: 6% - 4% = 2% x Rs 10 lakh = Rs 20,000

Investors can choose to invest either Rs 60,000 or Rs 20,000 as the case may be in a riskier investment like equities. They would be comfortable knowing that the initial Rs 10 lakh is safe at all times.

3. Safety Corpus Approach: This approach prioritises high returns on the capital by setting aside a safety corpus upfront. This provides comfort to an investor. He is then able to take a higher risk on the remaining pool of money.

Here, the most critical factor is to determine the amount of safety corpus that is sufficient. Once that amount is set aside, the rest of the capital can be invested in longer-term high risk, high return investments.

Example: One starts with Rs 10 lakh as initial capital and defines Rs 6 lakh as a safety corpus. The remaining Rs 4 lakh can be invested in equities or similar instruments.

Conclusion:

Wealth generation is not a scientific technique that can be replicated across all investors. It is influenced by each investor’s risk profile & sentiment, investment duration, decision making and the ability to go through market cycles. Doing the necessary groundwork and following a disciplined long-term approach is the most effective way to build a successful wealth creation strategy.

Nevertheless, the views shared here should not be construed as investment advice. These are general broad-based views based on the current environment. Specific advice to customers on asset allocation depends on the risk profiling of individual customers and the suitability of products.

The author is Senior Director, Kotak Investment Advisors Limited

DISCLAIMER: The views expressed are the author’s own, and Outlook Money does not necessarily subscribe to them. Outlook Money shall not be responsible for any damage caused to any person/organisation directly or indirectly.