B. VENKATESH, Business Line, 11/4/2013
There are two ways by which you can achieve your aspirations – increase your active income or your passive income or do both. By active income, we mean the income you earn from skill-based work. Passive income refers to income from investments. In this article, we discuss how you can invest to generate passive income to meet your aspiration needs.
A typical individual has the urge to continually improve his standard of living. The reason is, what psychologists call, hedonic adaptation. It refers to your tendency to quickly adapt to changes, good or bad, so that you maintain a stable level of happiness.
Suppose you earn Rs 1.5 lakh a month and you want to increase your active income to Rs 2 lakh a month. Within six months, you find a job that pays Rs 2 lakh a month. Will you be satisfied with your achievement? Psychologists argue that it is a matter of time before you revise your aspiration to Rs 2.5 lakh or even more! This continual need for a higher standard of living means that you cannot achieve your aspirations with only your active income. What should you do?
You should strive to improve your passive income as well. You can do so by setting aside not more than 15 per cent of your total investments every month to achieve your aspiration needs. Aspiration needs include all needs other than your current lifestyle requirement such as buying a house, saving for retirement and building a corpus for your children’s college education. Examples of aspiration needs are buying a vacation home or a luxury yacht. The question is: How should you invest to achieve your aspiration needs?
Remember, you are aspiring to achieve a significantly better standard of living. This means that you should either have substantial initial capital that can be invested in moderately risky assets or small initial capital invested in very risky assets to achieve your objectives. It is typical for most of you to have small initial capital to pursue your aspiration needs; for most of your investment capital will be consumed by lifestyle needs. You should, hence, consider high-risk high-return alternative investments.
For the purpose of our discussion, alternative investments include commodity derivatives, private equity, currency derivatives and direct investment in small- and- mid-cap stocks.
Now, investing in such securities requires caution. For one, trading in commodity and currency derivatives requires you to have short-term view on the prices. You could, for instance, have a view that gold is likely to decline further. Based on your view, you could set-up a short position in gold futures. For another, you should manage your risk efficiently. That is, you should be willing to take losses quickly and close your position if your view turns wrong.
Needless to say, trading derivatives or trading directly in mid-cap and small-cap stocks requires market-timing skills. If you do not possess such skills, you should seek the help of your broker or investment adviser, who could also help you with your private equity investments.
Investing for aspiration needs, unlike investing for lifestyle needs, requires more effort, given the nature of investments. You should have a disciplined approach to trading. Otherwise, you should consider outsourcing the investment decision to your stock broker or investment advisor.
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