The investment landscape can be extremely dynamic and ever-evolving. But those who take the time to understand the fundamentals and different asset classes make significant gains over the long haul. The first step is learning to differentiate the different types of investments and what each is on the “risk ladder.”
What is Investment?
Meaning of Investment: – An investment is essentially an asset that has been created with the intention of allowing money to grow. An investment involves putting capital to use today in order to increase its value over time. The money created can be used for a variety of purposes such as meeting a shortfall in income, saving for retirement, or fulfilling certain obligations such as paying off debt, paying tuition fees, or purchasing other assets.
For example, an investor may purchase a monetary asset now with the idea that the asset will provide income in the future or will later be sold at a higher price for a profit.
Investing can generate income for you in two ways; One is if you invest in a salable asset, you can earn income in the form of profit. Secondly, if invested in a scheme that generates returns, you will earn income through accumulation of profits. In this sense, ‘what is an investment’ can be understood as saying that investing is about putting your savings into assets or items that become worth more than their initial value or which over time generate income.
Investing is the act of allocating resources, usually money, with the expectation of generating an income or profit. You can invest in endeavors, such as using money to start a business, or in assets, such as purchasing real estate in hopes of reselling it later at a higher price.
Why should you Invest?
Investing is essential to achieve your goals. This is the only way to make your future better. By investing, you are also saving and accumulating a corpus for the rainy day. Moreover, making regular investments forces you to set aside an amount regularly, which helps you inculcate a sense of financial discipline in the long run.
- Financial Security: – People want to be financially secure and hence they need extra money. They are able to protect themself financially against any financial hardship that may strike them. An example might be an expensive life event such as a major health crisis or home destruction by cyclone or fire. Investing ensures that you are financially capable and safe to deal with such unforeseen events.
- Financial Independence: – Investment ensures that you have enough money to pay for your needs and not need to work in your old age without relying on someone else for the rest of your life. People invest with a view to build their wealth. This means they save over time and then invest their savings.
- Build your wealth: – People invest with a view to build their wealth. It means they save and then invest their savings over time. In the process, the income from investments, whether they are dividends or interest earned, can be reinvested in the same financial instrument or even anything else. This way you too can start investing and continue to build your wealth.
- Achieve your goals: – Some people set specific goals in life and invest to achieve those goals. For example, if your dream is of buying a house or a new car or traveling around the world then you will be motivated to invest. It is important that you list your goals and how much money you need to achieve that goal.
Difference between Investment and Savings
|1.||Saving simply means setting aside a part of your earnings over time.||Investment is based on the concept of earning a return or profit on the money that you had previously held in a fund or spent on the purchase of an asset.|
|2.||The amount saved is not subject to any risk and hence, does not help you earn any profit or return.||Here, the amount invested is subject to future return.|
|3.||Savings is to meet short goals and unexpected expenditures.||It is for long term wealth creation and capital appreciation.|
|4.||CDs (certificates of deposit), savings account, money-market instruments, etc.||Mutual funds, bonds, stocks, ETF’s, etc.|
Types of Investment
Following are the types of Investment: –
- Stocks and Equity: – A stock is an investment in a specific company. When you buy a stock, you’re buying a portion (a small piece) of that company’s earnings and assets. Companies sell shares of stock in their business to raise money or cash; Investors can then buy and sell those shares among themselves. Stocks sometimes yield higher returns but come with more risk than other investments. Companies can lose value or go out of business.
- Mutual funds: – Mutual funds allow investors to make a large number of investments in a single transaction. These funds pool money from multiple investors, then hire a professional manager to invest that money in stocks, bonds or other assets. Mutual funds can offer built-in diversification and professional management, they offer certain advantages over purchasing individual stocks and bonds. But, like investing in any security, investing in a mutual fund involves certain risks, including the possibility that you may lose money.
- Exchange-Traded Funds: – Exchange-traded funds (ETFs) combine aspects of mutual funds and conventional stocks. Like a mutual fund, an ETF is a pooled investment fund that offers an investor an interest in a professionally managed, diversified portfolio of investments. But unlike mutual funds, ETF shares trade like stocks on stock exchanges and can be bought or sold throughout the trading day at fluctuating prices.
- Fixed Deposit: – Fixed Deposit is an investment option offered by banks and financial institutions whereby you make a lump sum deposit for a fixed period and earn a predetermined rate of interest. Unlike mutual funds and stocks, fixed deposits offer guaranteed returns along with complete capital protection.
- Recurring Deposit: – A recurring deposit (RD) is another fixed-term investment that allows investors to invest a fixed amount every month for a pre-determined amount of time and earn a fixed rate of interest. Bank and post office branches offer RD. Interest rates are defined by the institution that offers it. An RD allows investors to invest a small amount every month to build a corpus over a stipulated time period.
- Public Provident Fund: – Public Provident Fund (PPF) is a long-term tax saving investment vehicle that comes with a lock-in period of 15 years. It is offered by the Government of India and the sovereign guarantees your investment. The interest rate offered by PPF is revised by the Government of India on a quarterly basis. The amount withdrawn at the end of 15 years is completely tax-free in the hands of the investor.
- Employees’ Provident Fund: – Employees’ Provident Fund (EPF) is another retirement-oriented investment vehicle that helps salaried individuals to get tax exemption under the provisions of Section 80C of the Income Tax Act, 1961. The EPF deduction is generally a percentage of an employee’s monthly salary, and the same amount is matched by the employer. On maturity, the amount withdrawn from EPF is also completely tax-free.
- National Pension System: – The National Pension System (NPS) is a relatively new tax-saving investment option. Investors subscribing under the NPS scheme will be compulsorily locked-in till their retirement and they can earn higher returns than PPF or EPF. The reason behind the same is as NPS offers plan options that invest in equities as well.
- Bonds: – A bond is a loan an investor makes to a corporation, government, federal agency or other organization in exchange for interest payments over a specified term plus repayment of principal at the bond’s maturity date. There are a wide variety of bonds including Treasuries, agency bonds, corporate bonds, municipal bonds and more. Likewise there are many types of bond mutual funds.
- Insurance: – Life insurance products are often a part of an overall financial plan. They come in various forms, including term life, whole life and universal life policies. There also are variations on these – variable life insurance and variable universal life insurance – which are considered securities and must be registered with the Securities and Exchange Commission (SEC). FINRA has jurisdiction over the investment professionals and firms that sell variable life and variable universal life products. Insurance products often are developed to meet specific objectives. For example, long-term care insurance is designed to help manage health care expenses as you age.
The table mentioned below will summarize the various investment options that are covered in this article: –
|S.No.||Investment||Type||Return Potential||Potential to Beat Inflation||Risk Involved|
|1.||Equity||Active||Very High||Very High||High|
|2.||Mutual Funds||Both active and passive||Moderately High||Very High||High|
|3.||Fixed Deposits||Passive||Moderately low||High||No Risk|
|4.||Recurring Deposits||Passive||Moderately low||Low||No Risk|
|5.||Public Provident Fund||Passive||High||Low||No Risk|
|6.||Employees’ Provident Fund||Passive||High||Moderately High||No risk|
|7.||National Pension System||Both active and passive||Moderately High||Moderately High||Moderate|
How to plan Investment?
The first step in planning your investments is to find the right investment that best suits your profile and needs. Here are a few things to keep in mind while planning your investments: –
- Choose investments carefully after doing enough research
- Don’t fall for quick-dues schemes promising high returns in a short period of time.
- Periodically review your stock and mutual fund investments.
- Consider the impact of tax on the return earned on your investments.
- Keep things simple and avoid complicated investments you don’t understand.
- Put your money in different types of investments which will minimize your investment risk. In case where none of your investments are doing so well and incur a loss, you can offset this loss with your other investments that earn you a positive or very high returns.
- Re-invest your income: – Every time you reinvest the income you earned from your investments; you increase your total investment that yields even more income next time at a given interest rate.
Why to start investment early?
You should start your investment as early as possible. When it comes to investing, time is money. The sooner you start, and the longer you stay invested, the higher the return you earn on your investment. By investing at an early stage of life, you learn a pattern of financial independence and discipline. An early investment teaches the real difference between investments and savings. Never think young age is a barrier to making an investment, as you are never too young to invest. The Little amount of money invested now will put more money in your pocket in the future.
Below mentioned reasons suggest that investment at an early age is a great idea: –
- Compounding Returns: – Early investments lead to compounding returns. The time value of money increases over a period of time. Regular investments made right from an early age can reap huge benefits at the time of retirement. Moreover, early investment facilitates your entry in the world of finance early. Your money grows with time. Because of early investments, you can afford things which others might not, at that age. This puts you ahead of others who prefer investing at a later stage of life.
- Save More: – With early age investments, you develop a habit of saving more. The more you invest, the more you get in future. To follow that thought process, you tend to save more by cutting on unnecessary expenses and divert such saved money towards investment.
- Secured Future: – There will be times in life when you will need urgent money to meet unavoidable expenses. During such times, the investments made at an early age can prove to be very handy and will help you get through the tough times all by yourself. The need for borrowing money from others decreases drastically with early investments.
- Become a Creditor: – An early age investment is indeed useful. When you have surplus money invested, you will never have a need to borrow money and become someone’s debtor. With money parked in the right investment avenues at the right age, you have money to lend to others i.e. you become a creditor.
- More Recovery Time: – If you invest early and even if you incur a loss, you have more time to make up for the loss on investment. Whereas, an investor who starts investing at a later stage in life, will get less time to recover his losses. Thus with early investments, your investment gets more time to grow in value.
- Support Your Retirement Plans: – Early age investments increase the probability of reaching financial stability at a young age. Saving for retirement from the age of 20’s rather than the age of 40’s is always a better idea. Life after retirement is more challenging than it has ever been, so planning for retirement now will lead to happier life after retirement.
Consider the following example; Suppose you start investing Rs. 1 lakh annually from the age of 22 and continue to do so till the age of 55, along with your friend who is already 34 years old. Suppose both of you invest in a scheme that offers returns of 10% per annum.
Let’s compare how your investments stack up against each other at maturity: –
|Age||You start at the of age of 22 years||Your friend starts at the age of 35 years|
|……….35||Rs. 12,00,000||Rs. 1,00,000|
|36………||Rs. 13,00,000||Rs. 2,10,000|
|…….54||Rs. 2,21,25,154||Rs. 78,54,302|
|55||Rs. 2,44,47,670||Rs. 87,49,733|
As you can see from the table above, the difference is huge. You earn much more than your friend because you started early. Your friend’s investment horizon is ten years shorter. You fully unleashed the power of compounding, while your friend did not. Therefore, the sooner you start investing, the better.