All about Investment

We all have been taught to save money from our income for our future requirements and also for urgent financial needs. None of the business and job stays permanent during bad times. At that time, if the primary source of income of any person gets hit then s/he must depend on the investment that had been done in the past.

Keeping liquid cash in savings doesn't generate any returns whereas investing in different businesses or asset class like fixed deposits, equities, bonds, real estate and commodities can generate a return.

There are two important factors that needs to be considered during investment:

Risk: Risk is an important factor that one needs to look while investment. Returns of any asset class depends on risk associated with it. Higher the risk, higher is the returns. Fixed deposits is considered safer whereas equities is considered riskier.

Time horizon of investment: Second important factor in investment is the time. If a young person invest his fraction of income for considerable long term, then he can create enormous wealth after few decades.

Generally, a younger person in 20s should consider taking slightly more risk than an older person. As a younger person has higher time horizon of investment and returns would get normalized in the longer term. Moreover, they have less dependency in the early stage of their life and they can invest more amount. Whereas considering a person who is in 40s, as they have dependency and they need some extra returns consistently should consider safer options. Hence younger person should be the risk taker and must invest (90-age)% of their savings in slightly more risky asset class like equities and mutual funds.

Let's consider one example and see how age at which one start the investment can make a huge difference in amount invested and returns.

Consider two boys Salman and Shahrukh, Salman started his investment at the age of 20 whereas Shahrukh started his investment at the age of 25. Both of them stayed invested till 45 years of their age. Considering CAGR(Compounded Annual Growth Rate)of 15% over the time horizon for both of them.

Salman started investing ₹5,000 monthly at the of 20 till he became 45 years old.

Shahrukh started investing ₹10,000 at the age of 25 till he became 45 years old.

So we can see the difference now, Salman had given more time for the investment and his principle investment was ₹9,00,000 lesser than Shahrukh, still he managed to built more wealth than Shahrukh at the age of 45. Earlier one start his investment in any asset class more the wealth one can build.

What are different asset class that are popular for investment?

1. Fixed Deposit: Its considered least risky investment and is quite popular in India. One can open, fixed deposit for any time horizon and banks or NBFC will give interest on that deposit as per the banking sector norms. Interest rate in India for 1 year fixed deposit is in a range of 5-7%.

2. Bonds and debt instruments: Investing in government or treasury bond to ensure risk free returns. Whereas investing in corporate bonds is risky and returns would be slightly more than the risk-free rate of treasury bond.

3. Real Estate: Generally investment in real estate is for very long term as price doesn't appreciate much for years. Huge amount is required to own a real estate property. There are many benefits of holdings real estate as one can generate rental income if the owners doesn't resides in the property. One can look to invest in REIT or REOC where amount required for investment in real estate is less but only disadvantage is that the investor doesn't have control over the property. Returns of real estate is linked with the inflation over the long term.

4. Commodities: Most common form of investment in commodities is by buying gold or silver. It is also considered as long-term investment. Generally its observed that the prices of precious metals doesn't appreciate for years but once price appreciate it compensate for returns of under-performing years. Like for gold, it consolidated from 2014 to 19 and in the last two years gold price had doubled. Whenever equity markets is in downtrend, prices of precious metals tends to appreciate.

5. Equities: Buying shares of any companies means buying businesses. If the business does well then the returns would be good but in case business fails, then investment can become 0. Analyzing those businesses is a difficult task as it requires time and expertise in that domain. Equities returns includes dividend and stock appreciation in value. Another way of getting exposure in equities is through mutual funds where a fund manager who has knowledge and experience in financial market domain does research and analyse companies and then invest in those. Mutual funds is a pack of group of stocks from different sectors and is diversified. So risk is lesser than direct exposure in equity market. For all this fund manager charges small fees as expense ratio. Also there are passive mutual funds like Index Fund where fund manager don't have to take any effort. Index fund is linked with Indian Market Indices like Sensex or Nifty and fund manager just have to buy constituents of these indexes in the same proportion to achieve same returns. As Warren Buffet has said, "95% of the fund managers can't beat Index returns in the long run" so it's advisable to invest in Index funds for long term. Index funds have less expense ratio compared to other active funds.

Buying any asset class is easier but holding it for long term and especially during bad phase is equally important. Like, in Covid crash all asset class had crashed and now many good asset classes had recovered back. If vision is for the long term, then refrain from looking at returns daily.