A commodity or asset purchased with the motive of value appreciation or generating income is termed as an investment. The term “appreciation” refers to the increase in any asset’s value with time. The goal of any investment bought is not to consume it, but to utilise it to build wealth in the future.
Table of Contents
How does an Investment work?
The purpose of investing is to generate income and increase the value of an asset over time. Any technique for earning future revenue might be referred to as an investment. This involves, for example, the acquisition of bonds, stocks, or real estate property. Buying a property that can be used to manufacture things may also be considered an investment.
Any activity made in the hopes of increasing future revenue might be considered an investment in general. When it comes to pursuing extra education, for example, the objective is frequently to broaden one’s knowledge and enhance one’s capabilities (in the hopes of ultimately producing more income).
A certain amount of risk is always connected with an investment since it is directed toward the possibility for future development or revenue. An investment may not provide any returns or may even depreciate in value over time. It’s possible, for example, that you’ll invest in a firm that goes bankrupt or a project that never gets off the ground. This is the main difference between saving and investing: saving is the process of amassing money for future use with no risk, whereas investing is the act of borrowing money for a potential future benefit with some risk.
Why should one Invest?
To reach your objectives, you must invest. You are saving as well as amassing a corpus for your future by making investments. Aside from that, the responsibility of making regular deposits as investments makes you keep aside a certain amount of money on a regular basis. This later becomes a good financial habit of saving money and investing.
The importance of investing and influence of inflation
Inflation is defined as an increase in the cost of goods and services. It reduces your purchasing power and lowers the value of your money. When the rate of inflation rises, you may buy fewer items for the same amount of money. The rate of inflation is beyond your control. If you want to remain ahead of inflation, you’ll need more money than you have now to buy the amount of things you want in the future with the amount of money you presently have. Money, on the other hand, does not increase on its own. If you want your money to expand, it must earn returns. You must invest in order to gain rewards. As a result, making investments is required to combat inflation. Inflation of 8% implies you’ll need 8% more money to buy the same thing next year than you do now. Earning inflation-beating returns is critical; otherwise, you may not be able to acquire goods and services in the future with the funds you are currently making. Here’s how an eight-year period of 8% inflation decreases the value of Rs 10 lakh:
|Amount in hand now
|At the end of 1 year
|At the end of 2 years
|At the end of 3 years
|At the end of 4 years
|At the end of 5 years
|At the end of 6 years
|At the end of 7 years
|At the end of 8 years
Different Types of Investments
There are several investing alternatives available to you. Before selecting to invest in any given investment opportunity, you must examine your needs and risk profile. Active and passive investments are two types of investments. Active investing necessitates changing assets in your portfolio on a regular basis, based on market and economic conditions. To engage in active investments, you must have sufficient time and investing understanding. Active investments are best shown by equity investments. Passive investments, on the other hand, do not require you to be actively involved in your investments. You put your money in and leave it there for a set period of time. It is also known as the buy-and-hold investing approach. This investing approach is recommended for individuals who do not have the time to handle their finances. The primary distinctions between active and passive investing are shown in the table below:
|Individuals who are well-versed in financial matters.
|As you acquire and retain shares for a longer length of time, your risk decreases.
|Higher because you exchange securities (mainly stocks) regularly in your portfolio.
|As you own stocks for a longer period of time, your risk decreases.
|Because you often purchase and sell shares, your risk is higher.
|Potential of Return
Investment options in India
Most investors want to make investments that will provide them with significant returns as rapidly as possible while minimising the danger of losing their principal. This is why so many people are on the search for great investment programmes that will allow them to quadruple their money in a matter of months or years while posing little or no risk. Unfortunately, there is no investment option that offers both a high return and a minimal risk.
Before investing in a product, you must match your risk profile with the product’s related hazards. Some investments have a high-risk profile but have the potential to provide larger inflation-adjusted returns over time than other asset classes, whilst others have a low-risk profile and hence lower returns.
Investment items are divided into two categories: financial and non-financial assets. Market-linked goods (such as stocks and mutual funds) and fixed-income products are two types of financial assets (like Bank Fixed Deposits, Public Provident Fund). Physical gold and real estate are examples of non-financial assets in which many Indians invest.
Here are some investing options that Indians consider when saving for their financial objectives.
1. Direct Equity
Stock investing may not be for everyone because it is a volatile asset class with no guarantee of returns. Furthermore, not only is it difficult to choose the right stock, but it is also difficult to time your entry and exit. The only silver lining is that, over long periods, equity has outperformed all other asset classes in terms of inflation-adjusted returns.
At the same time, unless you use the stop-loss method to limit losses, you run the risk of losing a significant portion, if not all, of your capital.
A stop-loss order is a purchase order that is placed in advance to sell a stock at a certain price. A demat account is required to invest directly in stock.
2. Equity Mutual Funds
Mutual funds that invest primarily in equities are known as equity mutual funds. An equity mutual fund scheme invests a minimum of 65 percent of its assets in equity-related instruments and equities, according to the Securities and Exchange Board of India (Sebi) Mutual Fund Regulations. An equity fund might be managed actively or passively.
Returns in an actively traded fund are mostly contingent on the capacity of the fund management to create returns. Passively managed index funds and exchange-traded funds (ETFs) monitor the underlying index. Equity funds are classified based on their market capitalization or the industries in which they invest.
3. Bank Fixed Deposit (FD)
In India, a bank fixed deposit is seen as a safer investment option than stocks or mutual funds. With effect from February 4, 2020, each depositor in a bank is covered up to a maximum of Rs 5 lakh for both principal and interest under the deposit insurance and credit guarantee corporation (DICGC) guidelines.
Previously, the maximum coverage for both principal and interest was Rs 1 lakh. You may choose between monthly, quarterly, half-yearly, or annual payments, depending on your needs.
4. Recurring Deposits
A recurrent deposit (RD) is another fixed-term investment that allows investors to invest a certain amount each month for a certain period of time while earning a set rate of interest. RDs are available in banks and post office offices. The interest rates are set by the entity that is providing the loan. An RD allows investors to put a little amount of money aside each month to grow a corpus over a certain length of time. RDs provide total capital protection and guaranteed returns. Risk-averse investors might choose RDs, which are similar to fixed deposits.
5. Public Provident Fund (PPF)
Many people use the Public Provident Fund as a source of income. Because the PPF has a 15-year term, compounding of tax-free interest has a significant impact, especially in the latter years. It is also a safe investment because the interest generated and the principle invested are backed by a governmental guarantee. Remember that the government reviews the interest rate on PPF every quarter.
6. Employee Provident Fund (EPF)
Another retirement-oriented investment vehicle is the Employee Provident Fund (EPF), which allows salaried employees to benefit from Section 80C of the Income Tax Act of 1961. EPF deductions are usually a percentage of an employee’s monthly pay, with the employer matching the same amount. The withdrawn corpus from the EPF is likewise tax-free when it matures. EPF rates are set by the Government of India every quarter, and your EPF investments are backed by the sovereign. However, you should keep in mind that you may only access your EPF investments if you satisfy certain conditions, and your EPF account will only mature when you retire.
7. National Pension System (NPS)
The Pension Fund Regulatory and Development Authority manages the National Pension System, which is a long-term retirement-focused investment product (PFRDA). The annual payment required to keep an NPS Tier-1 account active has been cut from Rs 6,000 to Rs 1,000. It includes, among other things, stocks, term deposits, corporate bonds, liquid funds, and government funds. You may determine how much of your money to invest in stocks through NP according on your risk level.
Which Investment Option should one choose?
Because there are so many investment vehicles to choose from, it’s natural for an investor to be stumped. If you’re new to investing, you’re probably unsure where you should put your money. Making the wrong investment decision might result in financial losses, which is something you do not want to happen. As a result, we advise you to base your investing selections on the following criteria:
- Age: Young investors often have fewer obligations and a longer investing horizon than older ones. When you have a long career ahead of you, you may invest in vehicles with a long-term perspective and gradually raise your investment as your income rises. This is why, for young investors, equity-oriented investments such as equity mutual funds are a better alternative than fixed deposits. Older investors, on the other hand, may prefer safer investments such as FDs. As you become older, you’ll need to change your investments.
- Goal: Short-term and long-term investment objectives are both possible. For a short-term aim, you should choose a safer investment, but for long-term ambitions, you should consider the high return-generating potential of equities. Some of your needs may be flexible and others may not be. Guaranteed-return investments are a wonderful choice for non-negotiable goals like children’s education or a down payment on a property. Investing in equities mutual funds or stocks might be useful if the objective is negotiable, meaning it may be postponed for a few months. Remember that if these assets perform well, you may be able to achieve your objectives much sooner than anticipated.
- Profile: Your profile is another thing to consider when selecting an investing choice. Factors such as your income and the number of financial dependents you have are also important. If a young investor has a lot of free time on his hands, he may not be able to take equity-related risks if he also needs to care for his family. Similarly, an elderly person with no dependents and a regular income source might invest in equities to increase their profits. This is why it is stated that when it comes to investing, one size does not fit all. To get the most out of investments, they must be carefully picked and properly organised.
|Potential to Beat Inflation
How to plan for investments?
The first stage in investment planning is to choose the best investment for your profile and needs. When making investing decisions, bear the following in mind:
1. After conducting thorough study, carefully select investments.
2. Don’t be fooled by quick-money scams that promise big profits in a short period of time.
3. Review your stock and mutual fund holdings on a regular basis.
4. Consider the tax consequences of the investment returns you generate.
5. Keep things simple and steer clear of sophisticated investments that you are unfamiliar with.
1. What distinguishes an investment from a wager or a gamble?
You are sending cash to some people or companies to be used to build a business, launch new initiatives, or sustain day-to-day revenue-generating in the form of investment. While investments might be hazardous, they have a positive expected return. Gambling, on the other hand, is focused on luck rather than putting money to use. Gambling is extremely dangerous and, in most situations, has a negative anticipated return (e.g., at a casino).
2. Is speculating the same as investment?
No, it’s not true. An investment is usually a long-term commitment, with the payback from putting money to work taking years. Investments are normally made only after thorough research and analysis to determine the risks and advantages that may arise. Speculation, on the other hand, is a one-way gamble on the price of something, usually for a short period of time.
3. What kinds of investments am I able to make?
Stocks, bonds, and CDs are simple to invest in for the average person. Stocks allow you to invest in a company’s equity, which means you have a residual claim to the company’s future profits and typically earn voting rights (depending on the amount of shares you hold) to influence the company’s direction. Bonds and CDs are debt investments in which the borrower invests money in a project that is projected to generate more cash flow than the interest owing to the investors.
4. Why risk your money by investing when you can save it instead?
Investing is putting money to work in order to increase its value. When you buy in stocks or bonds, you are placing your money into the hands of a company and its management team. Although there is some risk, it is compensated by a positive projected return in the form of capital gains, dividends, and interest flows. Cash, on the other hand, will not increase in value over time and may even lose purchasing power owing to inflation. Simply put, without investment, businesses would be unable to generate the cash necessary to expand the economy.