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ICICIdirect Posted on 03:00pm 12-Apr-2019

How to deal with Financial dilemmas?

While each situation may be the same the decision to be made will be different for each individual. It would be based on the given circumstances and even life stage. While there are no right or wrong answers the best possible choice has to be made after evaluating each outcome.

 

Spend or save?

This is probably the oldest dilemma all of us face. We are always taught to save for the rainy day. Most financial planners advocate that approach. On average, a savings rate of 25% and above is considered as a good savings rate. However, a better way to ascertain is to understand the goals you want to save for and then calculate the required saving rate.

Here are some steps that you can follow to evaluate how much you can spend. The equation so far was Income – Expenses = Saving but the way one should actually look at this is Income – Savings = Expenses.

Start by a look at your life goals like buying a house, child education, and marriage, retirement, etc. Work out how much you will need for each of these goals in the future than work backward to evaluate how much you need to invest for each of these goals. This is the sum that you should actually be saving, whatever is left can be spent.

 

Safe & low return investment or high risk & high return investment

This dilemma is faced by many investors, especially by those who have just started investing. Risk and return go hand in hand. Put simply, higher returns come with higher risks. The risk profile of an investor surely influences the choice of investments. Low-risk investors prefer safe investments and high-risk investors the other way round.

But a more scientific approach would be to opt for goal-based financial planning to find how much you should invest in debt (low risk and low return) and equities (high risk and high return). The first step is, to truly understand your risk profile. Risk Profile has two aspects, the ability to take the risk and the willingness to take the risk. The next step is to understand

Your investment objectives. Investment objective refers to the goal that you are investing for and when you will need the funds. The last step to choose a product is to know the investment horizon if you require the funds within 3-5 years, it is advisable to invest in debt. If the investment horizon is more than 3 years you can look at investing in equities with your risk profile in the background.

Clearly, the answer to the dilemma is not either or…an ideal asset allocation can be derived through a financial plan.

 

Value investing or growth investing

Many start investing in stocks and they are inevitably faced with a question should one follow Value Investing or Growth Investing. Value investing deals with buying a security at a substantial discount to its fair value. A value investor will ensure that the purchase price of the security should be so attractive that even a moderate sale should leave the investor with decent returns.

A growth investor, however, is more interested in the future growth of a company. When the corporate earnings in an economy grow at an average of 15%, if you come across a stock – XYZ - that has grown its earnings at 25% year on year and is expected to maintain the momentum for a foreseeable period of time, it makes a perfect case of a growth stock. Of course, such stock may have slightly higher valuations than the rest of the stocks.

If you are comfortable buying future growth and do not mind paying the premium for the same, consider growth investing. Value investing is all about assessing the fair value of a security at a moment of time. It also requires good amount of patience, as the market may take time to rectify the gap between the market price and fair price of the security.

However, one has to keep in mind that stock picking should come only after one has got the asset allocation right and has a diversified basket of stocks.

While investing in stocks, the next dilemma one faces is that of the style of analysis.

 

Fundamental analysis or technical analysis

The dilemma builds on when one wants to study investing on his own and decide to pick stocks for himself. He has to take a call on the method he wants to follow – fundamental or technical?

Fundamental analysis of a company involves analyzing its financial statements, its management, and competitive advantages, along with its competitors and markets. This analysis is carried out with a motive to ascertain the fair value of the stock.

On the other hand, technical analysis aims at forecasting the direction of prices through the study of past market data, primarily price and volume.

If you could interpret financial statements and study macro variables well, you can look at the fundamental analysis. If you want to use technical analysis to buy and sell stocks, be ready to work with multiple chart patterns and technical statistical tools. You may need specialized software to study chart patterns.