Investing is allocating money towards assets in the hope of making your future better. Investments are made with the view of earning returns, which grows your amount invested to a higher sum. We have covered the following in this article:
Why Should You Invest?
Investing is essential to achieve your goals. It is the only way to make your future better. By making investments, you are also saving and accumulating a corpus for a rainy day. Apart from that, making regular investments forces you to set aside a sum regularly, thereby helping you instil a sense of financial discipline in the long run.
Impact of Inflation and the Importance of Investing
Inflation, in simple terms, is a surge in the price of materials and services. It decreases the worth of your money and reduces your purchasing power. When there is a rise in the inflation rate, you buy fewer things with the same amount of money. You have no control over the inflation rate. If you are to stay ahead of inflation, you need to have more money to purchase the extent of the goods you intend to in the future with the money you have today. But, money doesn’t grow on its own. If your money has to grow, then it has to earn returns. To earn returns, you need to invest. Therefore, making investments is necessary to tackle inflation. Inflation at the rate of 8% means that you need 8% more money than what you have to purchase the same item next year. Here’s how inflation at 8% reduces the worth of Rs 1 lakh over eight years:
|Amount in hand now||Rs 1,00,000|
|After one year||Rs 92,000|
|After two years||Rs 84,640|
|After three years||Rs 77,869|
|After four years||Rs 71,639|
|After five years||Rs 65,908|
|After 6 years||Rs 60,636|
|After 7 years||Rs 55,785|
|After 8 years||Rs 51,322|
It is very important to earn inflation-beating returns, if not, you may not be able to afford materials and services in the future from the savings you are making now.
Types of Investments
You have numerous investment options to choose from. You have to assess your requirements and risk profile before deciding to invest in any particular investment option. Investments are broadly divided into active and passive. Active investment requires you to dynamically change assets in your portfolio, depending on the market and economic developments. You need to have enough time and knowledge of investments to indulge yourself in active investments. Equity investments are the best example of active investments. On the other hand, passive investments do not require you to be hands-on with your investments. You invest your money and stay invested for a certain duration of time. It is also referred to as the buy-and-hold strategy of investment. This strategy of investment is advisable for those who can’t spare time to manage their investments. The following table shows the major differences between active and passive investments:
|Parameter||Active Investments||Passive Investments|
|Suitability||Individuals with an in-depth understanding of finances||Everyone|
|Cost of investment||Higher as you frequently trade securities (mostly equities) in your portfolio||Lower as you buy and hold securities for a longer period|
|Risk involved||Higher as you frequently buy and sell securities||Lower as you hold securities for a longer time|
You have to choose to adopt either an active or passive strategy after you have assessed your requirements and risk tolerance level.
Popular Investment Options in India
You have numerous investment options to choose from. However, you have to ensure that you are investing in only those options that fall under your risk tolerance and serve your requirements.
The following are the top 7 investment options in India:
- Direct Equity Direct equity, commonly referred to as investing in stocks, is probably the most potent investment vehicle. When you buy a company’s stock, you buy partial ownership of that company. You directly invest in the company’s growth and development. You need to have enough time and possess the market knowledge to benefit from your investment. If not, then investing in direct equity is as good as speculation. Stocks are offered publicly listed companies through the recognised stock exchanges and can be bought by any investor who has Demat account and undergone KYC verification. Stocks are ideal for long-term investments. You have to actively manage your investments as various economic and business factors influence stocks. Also, you need to understand that the returns are not guaranteed and be willing to assume the associated risks.
- Mutual Funds Mutual funds have been around for the past few decades, and are gaining popularity amongst millennials. A mutual fund pools investment from various individual and institutional investors who have a common investment objective. The pooled sum is managed by a finance professional called the fund manager, who invests in securities and assets to generate optimum returns for investors. Mutual funds are broadly divided into equity, debt and hybrid funds. Equity mutual funds invest in stocks and equity-related instruments, while debt mutual funds invest in bonds and papers. Hybrid funds invest across equity and debt instruments. Mutual funds are flexible investment vehicles, in which you can begin and stop investing as per your convenience. Any individual may consider investing in mutual funds. You don’t need to have time or knowledge to invest in mutual funds as the fund manager takes care of portfolio constitution, and you only have to invest. However, it is advisable to invest in only those funds whose risk levels and objectives match yours. The returns are not guaranteed as they are dependent entirely on the market movements. Note that past performance of a fund does not indicate future returns.
- Fixed Deposits Fixed deposits are an investment option offered by banks and financial institutions under which you deposit a lump sum for a fixed period and earn a predetermined rate of interest. Unlike mutual funds and stocks, fixed deposits offer complete capital protection as well as guaranteed returns. However, you compromise on the returns as they remain the same. Fixed deposits are ideal for the conservative investor. The interest offered by fixed deposits change as per the economic conditions and are decided by the banks depending on the RBI’s policy review decisions. Fixed deposits are typically locked-in investments, but investors are often allowed to avail loans or overdraft facilities against them. There is also a tax-saving variant of fixed deposit, which comes with a lock-in of 5 years.
- Recurring Deposits A recurring deposit (RD) is another fixed tenure investment that allows investors to invest a fixed amount every month for a pre-defined time and earn a fixed rate of interest. Banks and post office branches offer RDs. The interest rates are defined by the institution offering it. An RD allows investors to invest a small amount every month to build a corpus over a defined time period. RDs offer complete capital protection as well as guaranteed returns. Like fixed deposits, RDs are recommended for risk-averse investors. v)
- 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 back your investments. The interest rate offered by PPF is revised on a quarterly basis by the Government of India. The corpus withdrawn at the end of the 15 years is entirely tax-free in the investor’s hands. PPF also allows loans and partial withdrawals after certain conditions have been met. Premature withdrawals are permitted to meet certain conditions, and you can extend your investment in a five-year block upon maturity.
- Employee Provident Fund Employee Provident Fund (EPF) is another retirement-oriented investment vehicle that helps salaried individuals get a tax break under the provisions of Section 80C of the Income Tax Act, 1961. EPF deductions are typically a percentage of an employee’s monthly salary, and the same amount is matched by the employer as well. Upon maturity, the withdrawn corpus from EPF is also entirely tax-free. EPF rates are also decided by the Government of India every quarter, and the sovereign guarantees back your investments in EPF. You can contribute more than the minimum prescribed amount under the Voluntary Provident Fund (PPF). However, you need to note that you can access your EPF investments only on meeting specific criteria and your EPF account matures only when you retire.
- National Pension System The National Pension System (NPS) is a relatively new tax-saving investment option. Investors subscribing under the NPS scheme will mandatorily stay locked-in until their retirement and can earn higher returns than PPF or EPF. This is because the NPS offers plan options that invest in equities as well. The maturity corpus from the NPS is not entirely tax-free, and a part of it has to be used to purchase an annuity that will give the investor a regular pension. You can withdraw only up to 40% of the entire corpus accumulated as a lump sum, while the remaining goes towards an annuity plan. Some government employees are compulsorily required to subscribe to NPS.
Which Investment Option Should You Choose?
Since there are numerous investment vehicles, it is normal for an investor to get stuck when selecting one. If you are new to investing, then it is likely that you are not sure as to where you should invest your money. Making the wrong investment choice can lead to financial losses, which you would not want.
Hence, we recommend that you base your investment decisions on the following parameters:
- Age Typically, young investors have fewer responsibilities and a longer investment horizon. When you have a long professional life in front of you, you can invest in vehicles with a long-term view and also keep increasing your investment as your income increases over time. This is why equity-oriented investments like equity mutual funds would be a better option for young investors than fixed deposits. But on the other hand, older investors can opt for safer avenues like FDs. You have to modify your investments as you grow old.
- Goal Investment goals can be either short or long-term. You should opt for a safer investment for a short-term goal and consider the high return-generating potential of equities for long-term goals. Some of your requirements can also be negotiable and non-negotiable. For non-negotiable goals like children’s education or down payment for a house, guaranteed-return investments would be a good choice. If the goal is negotiable, which means that it can be pushed back by a few months, then investing in equity mutual funds or stocks can be beneficial. Do not forget that if these investments perform well, you can even meet your goals much sooner than expected.
- Profile Another factor to consider while choosing an investment option is your profile. Factors like how much you are earning and how many financial dependants you have are also critical. A young investor with a lot of time in hand may not be able to take equity-related risks if he also has the responsibility to take care of his family. Similarly, someone older with no dependents and a steady income source can choose to invest in equities to earn higher returns. This is why it is said that one size doesn’t fit all when it comes to investments. Investments have to be chosen carefully and appropriately planned to get the most out of them. The following table summarises the various investment options covered in this article:
|Investment||Type||Return Potential||Potential to Beat Inflation||Risk Involved|
|Direct Equity||Active||Very high||Very high||High|
|Mutual Funds||Both active and passive||Moderately High||Very high||High|
|Fixed Deposits||Passive||Moderately low||High||No risk|
|Recurring Deposits||Passive||Moderately low||Low||No risk|
|Public Provident Fund||Passive||High||Low||No risk|
|Employees’ Provident Fund||Passive||High||Moderately High||No risk|
|National Pension System||Both active and passive||Moderately High||Moderately High||Moderate|
How should I plan my investments?
The first step in planning your investments is to figure out the right investment that fits your profile and needs. Here are a few things to keep in mind when planning your investments:
- Choose investments carefully after doing adequate research
- Don’t fall for quick-buck schemes that promise high returns in a short time
- Review your stock and mutual fund investments periodically
- Consider the tax implications on returns you earn on your investments
- Keep things simple and avoid complicated investments that you don’t understand
The sooner you start, the better
You should get started with your investments as soon as possible. When it comes to investments, time is money. The sooner you get started, and longer you stay invested, the more returns you earn on your investments. Consider the following example. Suppose you start investing Rs 1 lakh a year from the time you turn 25 years old and continue to do so until you turn 58 years, along with your brother who is already 35 years old. Consider you both invest in a scheme which offers returns at 10% a year. Let’s compare how your investments rack up against one another upon maturity:
|Age||You start at the of age of 25 years||Your brother starts at the age of 35 years|
|25||Rs 1,10,000|| |
|26||Rs 2,31,000|| |
|27…..||Rs 3,64,100|| |
|…..35||Rs 20,38,428||Rs 1,10,000|
|36 …||Rs 23,52,271||Rs 2,31,000|
|… 56||Rs 2,21,25,154||Rs 78,54,302|
|57||Rs 2,44,47,670||Rs 87,49,733|
|58||Rs 2,70,02,437||Rs 97,34,706|
As you can see from the table above, the difference is huge. You earn way more than your brother because you started early. Your brother’s investment horizon is shorter by ten years. You unleashed the power of compounding to the fullest, while your brother didn’t. Hence, the sooner you start investing, the better.