Explaining the most Important Steps of Investment Process

Investing helps you grow your wealth, beat inflation, and achieve financial goals. But with so many types of securities available today, one can easily get confused about which ones to choose, when to buy, and how long to stay invested. Without a proper plan, investors often make decisions based on emotions, trends, or what their friends are doing, which can do more harm than good.

The goal of having a clear Investment Process is to bring a defined structure to your investing journey. Let’s understand why this process is important and go through the different steps that make it effective.

Why The Investment Process Matters

Here are some reasons why every investor should follow a proper Investment Process:

• It helps you define your goals and select the right instruments that can help you achieve them.

• It aligns your investments with your risk profile and time horizon.

• It keeps emotions in check. Instead of reacting to market fluctuations or news, you’ll follow a logical plan.

• Sticking to a well-laid plan improves your chances of achieving financial success.

• Risk mitigation is an important part of the investment process. While it is impossible to eliminate risk completely, the process helps you reduce it to a level you can withstand through steps like diversification, ideal asset allocation, emergency planning, insurance planning, and regular reviews.

• Tax reduction is also an essential aspect of the investment process. An Investment planner helps you choose the right mix of investments that can legally reduce your tax liability (and retain more of your returns).

Steps Of The Investment Process

1. Assessing Financial Situation

The Investment Process begins with understanding where you stand financially. A good way to do this is by calculating your net worth. You simply subtract your total liabilities (like home or car loans, credit card dues, etc.) from your total assets (such as cash, investments, savings, property, etc.), and get a figure you can track with time. Net worth will also help you figure out how much you can invest initially.

2. Defining Financial Goals

Your investments should have a purpose, so each one of them should be linked to a specific goal. You can use the SMART goal-setting to define your short, medium, and long-term goals, and prioritise them based on urgency and importance.

3. Understanding Risk Tolerance

Your risk appetite depends on factors such as age, income, dependents, debt, responsibilities, and personality. You may be willing to take on high risk to earn higher returns, but that may not end up being the right approach because your financial situation doesn’t support it.

4. Setting Asset Allocation

Your risk tolerance will tell you about your ideal asset allocation. It means how much of your money should be used to buy different asset classes like equity, debt, gold, or real estate. For example, the asset allocation of a young investor may look like 75% equities and 25% debt.

5. Selecting Investment Style

There are many, many investment styles out there, such as growth investing, value investing, income investing, ESG investing, thematic investing, etc. But as a beginner, one of the most important choices you’ll make in the investment process is between active and passive investing.

• Active Investing: This style demands time and thorough research on your part. You’ll need to frequently monitor the markets, analyse securities, and be ready to make buy/sell decisions based on market conditions. It is better suited for investors who have the time and knowledge to manage their portfolios.

• Passive Investing: You can also outsource your investment decisions to a third party, such as an asset management company or portfolio management services. This is a more hands-off approach for those who want to invest but don’t want the stress of constant monitoring and decision-making.

6. Picking The Right Investments

The foundation of your investment process is now well-laid. The next step, and the hardest, is to select the securities that are not only aligned with your goals, risk tolerance, and investment horizon, but also perform well.

First, you must choose your investment vehicle, whether it’s mutual funds, stocks, bonds, ETFs, or fixed deposits. Then, compare the options within that category based on factors like past performance, risk level, fund manager experience (in case of mutual funds), credit rating (for bonds/FDs), expense ratios, risk-adjusted returns, company fundamentals (for stocks) and exit loads. For example, if you’re choosing mutual funds, you’ll need to decide between equity, debt, or hybrid funds, and then further select a sub-category. Then, you’ll need to compare different schemes based on returns, risk, fund objectives, etc..

For this step, consulting with investment advisory services can benefit you immensely. They can provide insights and recommend options that are well-aligned with your goals and risk profile.

7. Considering Tax Implications

Tax can take a lot out of your returns, which is why you should dedicate time to understanding how different products are taxed (like LTCG, STCG, STT, TDS, or dividend tax). Using instruments like ELSS, PPF, or NPS can even reduce your taxable income. Again, professional advice can add real value here, helping you structure your investments in a way that minimises tax liability legally.

8. Building an Emergency Fund and Getting Insured

Financial emergencies and unexpected expenses can dampen your progress, which is why building an emergency fund is important. Ideally, you should set aside 6 months' worth of essential expenses in a highly liquid option like a liquid fund to deal with situations like unexpected medical bills or car repairs.

Equally important is having adequate insurance coverage for both life and health. While an emergency fund handles short-term expenses, insurance takes care of much bigger risks. Together, they prevent you from taking on loans or liquidating your investments.

9. Monitoring The Investment Plan

And that’s it! You’re done with the hard part! While you’ve got your money working for you, don’t just forget about it. Market conditions change, and so do your financial situation and goals. During your periodic reviews (once or twice a year), you should evaluate how your portfolio is performing. If some investments are underperforming, you can adjust your portfolio accordingly.

Common Mistakes To Avoid

• Not Aligning Investments With Risk Appetite: In their pursuit of high returns, many investors invest in volatile assets like equities or cryptocurrencies without considering whether they can handle the ups and downs (emotionally or financially). It’s incredibly important to match your investments with your risk level.

• Not Building A Budget: Budgeting helps you keep track of your expenses, ensures you save a certain percentage of your income regularly, and most importantly, helps you live within your means. A disciplined budget allows you to prioritise your financial goals and commit to them.

• Ignoring Diversification: A broader exposure can help reduce the impact of underperformance in any one area.

• Emergency/Risk Protection: Neglecting emergency planning can be a major gap. Emergency funds can help you tackle short-term expenses like medical emergencies or urgent home repairs without having to prematurely liquidate your investments. Similarly, risk protection through life and health insurance ensures that your plan stays on track in the face of unexpected challenges.

• Past Returns Don't Guarantee Future Returns: While past performance of a security should be thoroughly analysed, it is not the only factor you should consider before investing.

• DIY vs Professional Help: The Investment Process can be done on your own, but jumping in without enough understanding is a common mistake. If you're new to investing or lack the time to manage your portfolio on your own, you should consider working with an investment advisor. These professionals work for a relatively small fee, so you can weigh whether or not the fee would be worth the time you save and the customised expertise you gain.

• Not Customising Portfolio: Your investments should reflect your financial profile, so what works for your friends or relatives may not work for you. Select your investments based on your goals, risk tolerance, and investment horizon.