The Idea of Investing
- May 16, 2018
- 7 min read
Disclaimer: This article is written for, and only for beginners of investment management. Therefore, you may find it redundant if you already a seasoned investor or if you are a student in a related field.
One way of defining investment is a measure or a set of measures that you take so that the value of the wealth entitled to you either grows or remains the same in the future. Anything from buying shares from the share market to keeping money in your savings bank account, buying mutual funds or trading in crypto all comes under the purview of investments. If you look around you, everyone, every person or entity, invests in some form or the other. Individuals, businesses or the government, everybody is involved in this ball game. In fact, any business that exists, is itself somebody’s investment, irrespective of how small or big they are.
Everybody is investing, but why?
There can be several objectived for investment. For an individual, there can be various motives, some of which are discussed below:
Getting wealthier– Everybody wants to get wealthier. With more money comes prosperity and better living standards. For investors with this objective, it is very important to be financially aware and actively engaged. It’s because these are the people who are bound to take risk (We will discuss the basic of risk and its nature in investments little later in this article). Usually, these people earn their daily bread and butter from their investments or spend a considerable time of their day involved in investment activities. Good examples for the same can be Warren Buffett or Rakesh Jhunjhunwala. However, don’t be bowled over by these big names. With sound knowledge and enough dedication, you can also figure in this list of successful investors. Who knows, you may even have the market-mind to stand out as a better example than those mentioned above. So do not hesitate to explore!
Ensuring financial freedom after retirement – This is the most common reason why Indian citizens, mostly from the middle-class and some from the upper-class, invest. Whether you are currently in your 30s or 50s, one day you will retire, there is no running away from that stoic reality, and when that day arrives you will need to fall back on your accumulated investments over all the years to generate interest income for your sustenance.
Statistically speaking, with improving health conditions in India and extended life expectancy, we hope you are going to have a long and happy life after retirement. This idea of living long is very good, but not as easy on your capacity to expend on things you desire, is it? In the modern generation, it is imperative that you never run out of money. With careful planning and systematic investment, this goal can be achieved. People with this objective mainly invest in provident funds, pension funds, fixed deposits, recurring deposits and other similar instruments. For this, the major challenge is planning in advance and investing the right amount, at the right time, in the right place.
However, it has been generally observed that people invest haphazardly in these instruments with narrow, immediate goals like tax deduction, and miss out on the optimum long-term benefit that they could have received otherwise. A quick suggestion for people with this goal is that, it is your life and your hard earned money, use it wisely.
Saving taxes – This is a short-term benefit that almost everybody has in mind while investing even nominal amounts in any of the instruments. Many of these investment instruments in India experience an increased demand during the month of February or March, which also happens to be the end of the financial year. This simple phenomenon occurs because investors have the said goal on their minds. Beware! It may seem apparently beneficial to save a few thousand bucks currently, but in the long run, you may miss out on much greater fortune if you get too involved in this goal.
Generate a second/multiple source(s) of income – This is a goal mostly for people with unsteady income. People who own small businesses or work in the fragile sectors are the ones who invest to ensure a secure future for themselves. They may do it by investing in available instruments or in several other ways, like starting new side businesses or investing in someone else’s business etc. Nevertheless, even if you currently have a steady income source like a government job or an established and excellent working business, it is highly advisable to invest with this goal too. The reason is simply- life is uncertain for everybody, being prepared for the same is of utmost importance. It’s not our intension to scare you, but when it comes to finance, both personal or institutional, it’s always a good idea to be prepared for the worst! This is called Risk Mitigation.
With all these goals in mind, the next question should be “” Firstly, we earn money from our jobs or businesses or by any other means, a part of which we spend for our daily expenditures like paying bills, buying food, clothes and meeting other requirements. The rest we save. So, the simple equation stands as:
Income = Expenditures + Savings.
Hence, whatever you save, you invest. Except for if you keep it in your own locker (where its value decreases over time due to inflation) or give it to a friend to help them. Generally, people keep this money in savings account or when the amount increases, they keep it in fixed deposits or even buy some assets (like land etc.) which can give returns in the future. But how much should you invest? The answer to this will depend on what is your objective and when do you expect a return. For example, if you are saving for retirement, a simple Google search will direct you to several online calculators that will give you an estimate based on how much money you will require after retirement and for that how much you need to invest from today.
Another common question that comes to the mind is “” Probably, 10 years beforehand. The answer might scare you unless you have a time machine. But, it’s never too late. Every time is a good time for a sensible and sound investment. Always remember, you can make money in both rising and falling markets.
Now the most important question, “” Here, it is very important to introduce and give a briefing about the term “. Risk, together with your expectation of return (increase in wealth), will provide you with the answer as to which investment is appropriate. This is often referred to as Risk-Reward relation. Irrespective of where you invest in, there comes an associated risk with the same. The risk of “What if you did not get the return you expected out of your investment?”
The safest of all possible investments is in Government bonds; it is an instrument via which the Government raises money from the market. Since the Government is the all-powerful body, the returns should be fixed, right? I mean, why would the Government void its own legal obligation. It makes this instrument the safest bet.
But even this investment is not absolutely free from risk. There is a slight possibility that the Government may not pay you back in the future in special cases like- the State ceases to exist or if the country is in an enormous debt which it can’t pay off. There have been such incidents in the past, although rare. Therefore, with every investment, there is an associated risk. For example, if you keep your money with a bank in savings account or as fixed deposit, the bank may default or if you invest in the share market, the share value may fall. The important observation here is that, different kinds of investments have different risks and returns. As the saying goes, “”
The best example for the same is crypto-currency. You must have come across news of people earning exceptional returns by trading Bitcoin and other similar crypto-currency. However, if returns of crypto-currency are so high, why do you think everybody does not invest everything in the same? The answer is risk. The chances of losing money while trading the same is equally likely. Now, how much risk you are ready to take depends only on you.
Let me help you with an example. There are two instruments, A and B. Instrument A has a probability of giving you a return of 100% (i.e. $100 becomes $200) half of the time and a return of -40% (i.e. $100 becomes $60) in the rest of the cases. Instrument B will give you a 10% return (i.e. $100 becomes $110) 3/4th of the time and -8% (i.e. $100 becomes $92) in the rest of the cases. Let’s say you need to invest $10,00,000. In which of the instruments, A or B, will you invest?
Most will answer instrument B because even though the returns will never be as high as that from A, the risk of losing money is also lower. But, what if you need to invest $10? Probably many will now say instrument A, the reason being that they are ready to lose an amount as small as $10.
So, you need to find instrument/instruments for investment which can give you highest return for the lowest risk given the maximum amount of risk you can take for a given investment. The above example may look easy, but in real life, doing this may get tricky because it is pretty difficult to predict risk and return both accurately for almost all instruments.
But, to minimize risk, one very important consideration that needs to be taken into account, which can also be called as the first rule of investment, is that “” In other words, do not invest all your money in one asset or instrument. It is always better to diversify your investments in parts so that you never lose all your money at once.
Depending upon how much risk you can take, investing a part of your wealth in instruments with very low risks like bonds, fixed deposits etc., another part of your investments in slightly higher risk instruments like mutual funds, and the remaining part in very high risk instruments like Equity(shares) and derivative is the best strategy. Coming up with the right proportion will not only minimize your risk but also maximize associated returns.
And with that we conclude our article on the idea of investing. For any query or feedback please write to us at insigniainvestments@gmail.com
Stay tuned for more such articles that helps you get one step closer to being the intelligent and rational investor.
Till next time! Happy investing!
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