When I was a beginner, my biggest investment dilemma was identification of best investment options to build a perfect portfolio. When I was in this dilemma only one thing was clear that “i want to save my hard earned money to invest it on assets and not on liabilities”. People generally save to buy a house, car, TV, motor bike etc. But we cannot ignore the need of liabilities in our live. A good house, a nice car, a furnished home, all adds to our standard of living. There must be a perfect balance between savings that is focused on buying assets and other which shall buy the required liabilities. This is the reason why I have classified savings as:
- Liability savings.
- Asset savings.
The objective of asset savings is to accumulate assets and liabilities savings buy needed liabilities. People often forget to do this differentiation in their savings. People save and then invest on assets like shares, bonds etc and ultimately redeem to buy liabilities. This is not right, savings focused on assets should always buy more assets and never a liability. The fund generated by liability savings should be used to buy liabilities. With this concept, we will briefly discuss the affect of the above two types of savings on your financial independence:
- Asset savings – makes you richer
- Liabilities savings – makes you poorer but increases your standard of living.
It is not sufficient to think about savings and investment in isolation. The savings should make you richer and in parallel increase your standard of living. If an investor can manage this balance then he can be sure to reach his goal. The goal of asset savings is to give the investor a financial independence. Financial independence decreases the investor’s dependency on their job. Investors who are 100% financially independent no longer needs to do job to earn their livings. Lets assume that an investor decides to save and invest $100 equally among asset saving and liability saving. At this the choice of a suitable investment options becomes most important. The choice of investment option is dependent on the time span for which you can keep your savings invested:
- Asset savings – long term investment
- Liability savings – short term investment.
Investment time horizon for asset savings is minimum 5years. It means if you buy one a share today then you must not sell it for next 5years. Liabilities investment has time horizon of 1year to less than 5years. Investment options like shares and mutual funds (equity linked) are best choice for long term investment options. Bank fixed deposits and recurring deposits are best choice for short term investment options.
- Asset savings – invest on shares and equity linked mutual funds.
- Liabilities savings – invest on bank fixed deposits and recurring deposits.
The quantum of money an investor allocated to asset savings and to liability savings is very critical. If you are saving more for liabilities then your speed of becoming financially independent will be slower. If you are saving more for assets then you will be always short of funds to buy the needful liabilities. It is very important to know your optimum levels of savings. In most cases you will find that your savings are not enough to buy the needful liabilities at the desired time. In such situations do not cut you budget of asset savings; you must look for other avenues to meet the deficit. This is one reason why so many people start doing business (work from home types) to make up for this deficit.
The author is a big enthusiast of the process of investment and aspires to set-up a highly successful online business of himself.
He is a firm believer in the concept of ‘working for self can make this world a better place to live’. He has also been heavily influenced by the theories and practices of Warren Buffett and would like to practice investment just like his guru.