Personal Financing 101 - Why to invest and where?

What is the best investment decision you ever made?

How do you invest the money you earn?

Do you keep a track of your savings and expenses?

What percentage of your take home salary goes into savings?

Do you invest in 100% risk free instruments or make a bouquet of risk free and risky instruments?

We encounter quite a lot of these questions in our daily lives. Often hearing our parents constantly nagging us to put more money in investments and less of it towards luxurious spends does leave us infuriated.

Well, the fact of the matter is, quite a lot of us do not plan our investments well. Parking it entirely in 100% safe instruments (so to say) does not make us a smart investor. If we do not plan our investments well, owing to the inflation which adds on year-on-year, we end up devaluing our money. So, keeping our money parked in our savings account, yielding us a 4% return, is a decrease in the value of money (negative returns at 1-2%), when we adjust it against inflation (assuming inflation at 5-6%).

There are three factors which should influence the type of investment we want to go ahead with:

a.     Risk taking appetite – Ability to take risk decides whether we invest in totally safe instruments (so to say) or what is the magnitude of risks we are willing to take. As a rule of thumb, with growing age, one’s risk appetite reduces. Hence, one can invest more in risky instruments (to the tunes of 70% of their savings) at a younger age. As one progresses in life and assumes more responsibilities, one starts to park money in relatively safer instruments.

b.     Expected returns – This is the parameter to be careful about. Getting and maintaining double digit returns (more than say 20%) is a challenge. One may be able to manage good returns in a short term time frame, but maintaining it throughout the life cycle of our investment can be a challenge. Hence, maintaining the timing of one’s entry and exit is important.

c.      Requirement – Depending on whether the requirement of a particular fund is in long term or short term, one can take a call on whether one wants to invest in instruments which give returns in short term (2-5 years) or long term (5+ years).

There are a number of instruments available, which can help one in managing their funds properly and getting a good return on one’s investment.

Investment products can be bucketed into two categories:

a.        Financial assets like equity, PPF, FD etc and

b.        Non financial assets like real estate and gold.

Defining risk as low, moderate or high, one can classify all the financial assets and non-financial assets as follows:

  

Option	Asset Type	Risk appetite
Direct Equity	Financial Assets	High
Equity mutual funds	Financial Assets	Moderate-High
Debt mutual funds	Financial Assets	Low-high
Senior Citizens Saving Scheme (SCSS)	Financial Assets	No risk
National Pension Scheme (NPS)	Financial Assets	Low-high
Bank FD	Financial Assets	Low
RBI Taxable bonds	Financial Assets	No risk
Public Provident Fund (PPF)	Financial Assets	No risk
Real Estate	Non Financial Assets	High
Gold	Non Financial Assets	Low-moderate

As we see, there are 10 investment opportunities available for one to make a decision. Coming to the second important factor while making an investment decision, let’s look at the expected returns from each of the above instruments.

Option	Expected returns
Direct Equity	13-20%
Equity mutual funds	10-12%
Debt mutual funds	7-8%
Senior Citizens Saving Scheme (SCSS)	8.3%
National Pension Scheme (NPS)	~8%
Bank FD	6.2%-7.5%
RBI Taxable bonds	7.75%
Public Provident Fund (PPF)	7.6%
Real Estate	3%-4%
Gold	8%-11%

10 investment opportunities…3 types of risks…10 different types of return rates.

So, which one to choose from?

Drilling down to one from the above list can be a nightmare!

Which one is my personal best? Well, Direct Equity.

With the right knowledge, one can rely on direct equity to give best returns since:

a.      Equity offers good returns (13-15% average). If invested correctly, equity has delivered higher than inflation adjusted returns compared to all other asset classes.

b.       You can earn good returns even within a short time period without remaining invested for a long time

c.       With the correct timing of one’s entry and exit in a particular sector/industry/company, one can   maximise one’s returns.

How does one take a call on equity?

What industries to choose?

What companies to look for?

What should be the entry and exit price?

What are the forces that drive the prices of a company?

These are some of the commonly asked questions which need to be answered before one can take a step forward and start investing!

To answer these questions, one needs to understand about ‘Fundamental Analysis’ and ‘Technical Analysis’, which shall be the topics which will be introduced in the next section of this blog post series.

Stay tuned till next Thursday!

Till then, Happy Learning!