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“I really don’t understand the investment jargon. Just tell me where to invest!”
“There are so many investments to choose from, I am totally confused.”
“How do I go about selecting the right investment for me?”
If thoughts or questions such as these have ever crossed your mind, then read on! This write-up provides a step-by-step guide on how one should go about deciding the right kind of investment that meets one’s needs.
Investing your hard-earned money should be done with specific objectives in mind. It cannot be done aimlessly or in vacuum, or else the overall outcome may not be optimal.
You should also quantify these objectives. For example,
Arriving at such specific objectives may not be easy. You would need to consider all possible future requirements such as your retirement, buying a residential property, funding for children’s higher education, funding for marriage, overseas holiday with family, unforeseen hospitalisation expenses etc.
Also, the quantification of the amounts required would need to take into account the inflation rates that may apply to each of such future outgoes. For example, your monthly outgo is currently Rs.25,000, with an inflation of 10% p.a., in 15 years’ time when you retire, it would be more than Rs.1.04 lakhs. Thus, your objective should be to receive a monthly income of say Rs.1 lakh when you retire in 15 years’ time and not Rs.25,000 that you are spending today.
Having identified and quantified your overall investment objectives, the next step is to understand your own self and your personal circumstances. This may involve answering questions such as these-
This is an important step, given that an investment which is ‘right’ for one individual may not be right for another. This is because, for example, even if the overall objectives and other circumstances may be identical, one individual’s risk-taking abilities may be different than the other’s.
It is important that the investments chosen provide a good fit with the overall personality of the investor himself/herself. If not, there is a risk that the investor may not continue with the selected investment, which in itself may be the reason for the set objectives remaining unfulfilled.
The next step in the investment journey is to analyse the different types of investments that are available. This may be cumbersome, but absolutely essential. You may very well seek help from professional financial advisors. However, it is also important for you to understand what you are investing into!
The various investment avenues may be analysed in their main characteristics as set out below:
You may need to consider whether or not a given investment avenue is regulated by an independent regulatory authority and the overall maturity of the regulatory environment itself. Absence of an appropriate regulatory structure may mean:
For example, the banking products are well regulated in India, with the Reserve Bank of India governing the functioning of the different banks operating for several decades. On the other hand, the regulators for property investment (i.e. the Real Estate Regulatory Authorities) are relatively new and the regulatory structures there are still evolving.
What are the available tenure for various investments? Are they meant to be short-term investments or long-term investments?
One should note that an investment that is meant for the longer term may not provide optimal returns over the short term. Hence, it is important to understand the exact tenure of the investment concerned.
You may require some investments that are ‘liquid’ in nature – i.e. they can be easily sold off without any delay or heavy penalty, in case of any emergency need for funds (e.g. to meet costs related to sudden hospitalisation of a parent). On the other hand, ‘illiquid’ investments are the ones that either take time to sell (e.g. property) or upon early liquidation, may result in heavy penalties (e.g. certain types of life insurance products).
Some investments provide guaranteed investment returns, whereas others don’t provide such guarantees. Depending on the nature of your investment objectives, you may or may not want an investment that provides returns that are non-guaranteed. For example, if your investment objective is to pay for your child’s university education in two years’ time, you may want to be sure that your investments will definitely deliver the required investment returns. However, if your investment objective is to fund for your child’s overseas education in ten years’ time, perhaps, you may be more relaxed about your investments not providing guaranteed investment returns.
It is important to understand that when an investment avenue provides a guarantee, it is typically able to deliver a return that is lower than the investment avenue that doesn’t provide such a guarantee. Hence, if you need your investments to deliver a higher return, you should be prepared to accept avenues that do not provide such guarantees, as such investments may deliver a higher investment return over the long-term.
It is important that a large proportion of your investments should be such that the investment returns earned are higher than the inflation rate at which your expenses increase. In the absence of this, the ‘purchasing power’ of the investment income would go down over the years and you may be required to sell off the investment itself at some stage, leaving your investment objectives un-fulfilled.
When you consider investment returns, you should consider them after taking into account any tax you may pay on the same or any tax benefits you may get on the investment itself. Deciding on the investment avenue based only on the investment returns before tax may be grossly misleading.
The impact of taxation may need to be considered at three different stages –
At the time of investment -whether there are any taxation benefits available on your investments;
During the tenure of the investment -whether the returns from the investment are taxable; and
At the end of the investment tenure -whether there are any tax implications on the proceeds received from the investment.
One should also consider the exact tax rates that may apply at different stages of the investments, based on the applicable tax rules and his / her personal circumstances.
For any investment avenue, these above-mentioned characteristics may keep changing regularly. Hence, it is important to consider them every time one needs to make an investment decision. A summary of the above-mentioned characteristics across different investment avenues is set out in the table below.
| No. | Investment | Regulatory structure | Tenure | Liquidity | Level of guarantees | Protection against inflation | Tax implications |
|---|---|---|---|---|---|---|---|
| 1 | Cash | N.A. | N.A. | High | N.A. | Nil | N.A. |
| 2 | Gold / silver jewellery etc. | N.A. | N.A. | High | N.A. | Low |
|
| 3 | Property | Less matured | Long | Low | Nil | Medium to high |
|
| 4 | Bank fixed deposits (FD) | Matured | Short to medium | Medium to high | Guaranteed | Low |
|
| 5 | Public Provident Fund (PPF) | N.A. (Govt. scheme) |
Long | Low | Guaranteed (although interest rates declared may vary from year to year) | Medium |
|
| 6 | Employees Provident Fund (EPF) | Matured | Long | Low | Guaranteed (although interest rates declared may vary from year to year) | Medium |
|
| 7 | National Savings Certificates (NSC) | N.A. (Govt. scheme) |
Medium | Low | Guaranteed | Medium |
|
| 8 | Unit-linked life insurance (ULIP) | Matured | Long | Low | Non-guaranteed | Medium to high(b) |
|
| 9 | Non-ULIP life insurance plans | Matured | Long | Low | Guaranteed and non-guaranteed(a) | Low to medium(b) |
|
| 10 | Mutual funds | Matured | Short to medium | High | Non-guaranteed | Medium to high(b) |
|
| 11 | Equity shares / stocks | Matured | Medium to long | High | Non-guaranteed | High |
|
| 12 | National Pensions Scheme (NPS) | Matured | Long | Low | Non-guaranteed | Medium to high(b) |
|
Having equipped yourself with the knowledge of the characteristics of different investment avenues, you would then need to derive the amount of investment that you need to make in the relevant investment avenues, such that they will be able to deliver your set objectives.
The amount of investment required may be calculated as a lump-sum (i.e. the amount to be invested today), or a series of amounts to be invested in each of the future months and years, up to the date that the funds for the set objectives are required. Whilst deriving the required amounts of investment to be made, you may need to take into account the net-of-tax investment returns expected to be generated in the future on your investments.
For example, if you are a risk-taker investor and need Rs.50 lakhs to fund for your child’s university education in 15 years’ time, and if the likely net-of-tax investment returns on equity oriented mutual funds or equity shares / stocks are say 12% p.a., you may need to invest the following amount in equity shares / stocks or equity oriented mutual funds:
However, if you are a risk-averse investor and want absolute certainty that the amount of Rs.50 lakhs must be available at the end of 15 years, and if the expected net-of-tax investment return on a non-ULIP, non-participating life insurance policy for 15 years is say 5.5% p.a., you may need to invest the following amounts in such a life insurance policy:
Don’t worry about how the above-mentioned amounts are derived! You may be able to seek support from your financial advisor to derive these amounts, if you are unable to do it. However, the important point to note is that depending on the type of investment selected and therefore the expected net-of-tax return that you may generate on your investments, the amount you may need to invest may change significantly.
Having decided on the amounts to be invested in different types of investment products, the next step is to decide the ‘right’ entity that provides such products.
For some of the products (such as the PPF, NSC), the provider is the Government of India – so there is nothing to decide. However, for others (e.g. fixed deposits, mutual funds, ULIPs etc.), where there are multiple providers, you may need to decide which provider to buy the product from. How does one select one company over another?
There are several factors to consider. For example -
Again, information pertaining to many of these may not be easy to find and you may need to rely on your financial advisor for support. However, do try to understand the reasoning behind the recommendations made by your financial advisor instead of relying on him / her blindly.
If you are not relying on the financial advisor and are able to decide on the company to invest in, you may also be able to invest directly instead of going through any intermediaries (such as an agent, broker etc.) Many companies offer their customers the ability to invest in their products directly online, which may mean that you may be able to save on the cost of intermediation and earn a slightly higher level of returns on your investments.
Once you have purchased the appropriate types of investments, that is not the end of the story!
It is important that you regularly monitor the performance of your investments and ensure that you are on the right track to meet the investment objectives set. If your investments are not performing as per expectations, you may need to take a corrective action.
However, monitoring the performance of your investments doesn’t really mean reacting to each of the adverse news, market rumours or market development, and liquidating your investments or shifting investments from one provider to another. Such hasty actions may actually result in a sub-optimal outcome for you, as they may involve additional costs and penalties, resulting in an overall lower return on your investments. It does, however, mean taking informed decisions at an early stage before it becomes too late.
Again, you may find it useful to consult your financial advisor to ensure that your investments are on the right track.
Finally, apart from the knowledge and right advice, one also requires discipline when it comes to investing for a set objective. As much as possible, one should not liquidate the investments pre-maturely and for a purpose other than the original objectives for which the investments are being made.
Happy investing!