The Variety of Investment Options

In a world which is regularly threatened by the vagaries of inflation and volatility, it becomes a challenge for the individual investor to seek refuge from these turbulences, majorly due to the lack of knowledge about the multitude of options available in the free market that provides a better shot at surviving the vagaries of financial ups and downs.

Sometimes, individual investors do know or have at least heard about the ‘other options’ to keep their money afloat but are too tied down by their regular activities to invest time and understand the workings of these instruments.

Today’s article tries to address this caveat in the common investor's knowledge by presenting to you a condensed risk-aligned perspective of all the different instruments present in the market, what they offer, and what they lack.

We will go down this road from the last risky, benign instruments, to weapons of mass financial haemorrhage, to help you feel the incremental risk exposure that one has to undertake to achieve that increment basis point (0.01%) of return.

Let's get started!

Bank Accounts

The safest of all investment instruments available in the market is that of the bank accounts. The generation right before ours with vouch for Fixed Deposit (FD) accounts and Recurring Deposit (RD) accounts, with all honesty. And the reasoning for this intense faith in the bank account is fairly simple- the returns are stable and fairly good, India banks are regulated thoroughly by the Government of India (and respectively for every other country as well), they offer sufficient amount of liquidity and undertake little to no understanding of apps/internet for their withdrawal.

While FDs and RDs are term deposits, with long term commitment, saving banks account for the individual investor offer enhanced liquidity with interest earning capability.

The banking system has been fairly robust since the nationalization the various bank in the late 1980s, and the amount of respect the central bank- Reserve bank of India, commands is a testament to the success with which the banks have ushered into the present century.

The downside, however, has not been highlighted adequately to the masses. Being a secure and safe form of investment, they offer little spread over inflation. What this means is that when inflationary forces start rising the returns that you earn from keeping your money in FDs or RDs will not be able to cover for the increased inflation, and thus your investment will be losing value instead of gaining the same.

And it is again fairly simple to understand why inflationary forces are a real threat for a nation like India, or any other emerging economy. As the government invests more and more into infrastructure and other assets to fuel the increase in the gross domestic product, the higher demand will pull up prices, which in turn will result in higher inflation. Being a growing country, this boost to the GDP is expected, and so is the natural consequence of inflation.

So if you are young, say in your mid-20s to mid-30, you’ll be a part of this economic cycle for at least another 4 cycles. This means that you will end up making barely a minimum if you keep all of your eggs in the RD/FD nest.

Thus the natural advice is to keep some in FD/RD for liquidity and security reasons, but undertake other means of investment to keep your savings safe from the eroding forces of inflation.

Certificates of Deposit/ Treasury Bills

Certificates of Deposit (CDs) or treasury bills (T-bills) are medium to long term commitments of funds (usually with the Government) which offer stable returns with rates that help an investor cover himself/herself partially from the volatility in inflationary forces.

CDs are very much similar to FDs other than the fact, that sometimes CDs come along with call options, because of which they offer higher interest rates.

However, early withdrawal of CDs attracts penalty. Sometimes the rates on CDs are geared to expected inflation, and thus offer some protection from rising inflation.

T-bills are short term debt instruments that the Government issues with the tenor of the investment being under 1 year. Treasury bills are presently issued in three maturities, namely, 91 days, 182 days and 364 days. Thus they are very secure and liquid forms of investment, with attractive pricing. Being geared to the market, their prices vary regularly and this cuts two ways- the rates adjust to take care of the inflation, while the selling price may go down in case you want to exit before maturity.

The Reserve Bank of India conducts auctions usually every Wednesday to issue T-bills. The rationale is that since their maturity is lower, it is more convenient to adjust your earnings in interest with the changing market scenarios.

High-Quality Corporate bonds

Corporate bonds are instruments that a corporation issues to raise debt from investors. They are traded in a highly liquid market that adjusts to interest rate and market sentiments pretty rapidly. They offer substantially higher rates of returns and are avidly traced by multitudes of investors, banks and funds. Thus you will find readily available research reports on the credit servicing capabilities of the companies through a simple google search.

Moreover, all the bonds that are issued by the top corporations, globally, are rated by credit rating agencies like Moody’s, Standard & Poor’s or Fitch. In India companies like ICRA, CARE, CRISIL, Brickwork, etc. actively provide ratings for the companies.

These instruments are essential for portfolios, as unlike equity, which does not have any assured cash inflows, bonds that are rated investment grade have assured cash inflows. This assurance of cash inflows help you plan for and match your commitments in the long and short terms.

However, they are not the most favoured instruments by the individual investor, as they are usually juxtaposed with equity, and the glamourous returns in the equity segment make these instruments look comparatively dull.

If you are a cautious investor, your portfolio should have a healthy weight in high-grade bonds, simply for the safety that they provide. They will help you equity savings survive the vagaries of the economic boom and bust.

Large-cap Stocks

Now that we have arrived in the high-risk-high-return zone, we will introduce to you the fortune maker of the most notable investors in the world- stocks.

Large-cap stocks are usually the equity shares of the largest and successful corporations of a nation. They have a substantial amount of the public capital invested in them, through individual investments, mutual funds, foreign investment, etc.

The beauty of the large-cap stocks is that they have historically helped create wealth in the long run, as larger companies have usually been able to survive more economic cycles of growth and recession, compared to their smaller counterparts.

There are only two downsides to investing in large-cap stocks. The first is that they are usually compared with real estate, and there are these brisk periods of time, that come regularly, that real estate investing becomes more lucrative than investing in large-cap stocks. The second is that they have been and will always be compared to the small-cap stocks, some of which have given the most astronomical returns in the whole of the investing universe, which is where large-cap lose their lustre.

But if you are like me, who prefers calculation over speculation, my advice to you will be to load your equity portfolio heavily with large-cap stocks. They have historically been consistent performers, require less readjustment of the portfolio, and you will be penalized less if you are unaware of most recent market developments.

Real Estate

Human beings have been fighting over land for as long as history can remember. And definitely for reason!

Land value appreciation has been challenging the returns from equity market for quite some time now. This discovery has led to the development of a new form of a fund called REITs- Real Estate Investment Trust. Unlike other funds that hold diversified financial assets, these funds invest in diversified land holdings.

With increasing urbanization, technological advances and infrastructural growth is absolutely natural to see as to why real estate will provide returns in the near future. Many Indians nowadays implement this strategy with a twist. With increased earnings, people buy more and more apartments/houses and put them up for rent. Not only does this provide an investment avenue but, it also provides a stream of alternative cash flows.

However, it remains to be seen as to how effectively people can generate an analytical approach to select land/housing for investment purposes, as a standardized approach for the same is still absent.

Unless you have a large diversified capital base, with sufficiently adequate risk taking capability, do not engage in this segment of investment. As on date, India has nil REITs. Blackstone Group has been looking to set up one, and when it does, consider this kind of investment a possibility for the individual investor.

Small-Cap Stocks

Once upon a time, small-cap stocks like Titan and Hero Honda had spring-boarded the financial wealth and fame of investors like Rajesh Jhunjhunwala to prominence. Many investors, like Peter Lynch, have also been extremely successful in making the right picks in the small-cap stocks. This segment of the market has produced the highest excitement and deepest losses.

Small-cap stocks have a low amount of public capital invested in them, have lesser liquidity and are not tracked widely by publicly available equity research reports. Because of this hindrances, their valuation is difficult, and a lot of research suggests that they are available at deep discounts. This gives them the capacity to propel their valuation when the value proposition in these companies becomes public knowledge. This is how they become multi-baggers and create extraordinary amounts of wealth for their investors.

However, be cautious of the fact that they are hit the worst when a market downturn arrives. And finding a multi-bagger in the nascent stage is like looking for a needle in a hay-stack!

Unless you have an adequate understanding of the industry, have a deep sense of understanding of the specific company and its operations, it is extremely difficult to find out which small-cap will be tomorrows large-cap and which one will turn out to be a rotten apple.

Derivatives

Many investors engage exclusively in derivatives and take home tonnes of money. This entices the everyday ordinary individual investor, and he tries his luck on the same- only to realize that all is an investment is wiped clean to ₹ 0.0.

Derivates are a world of their own in terms of investment. If you are looking for avenues to invest your entire life’s saving, derivatives are a strict no-no.

Unlike bonds and equities, which might lose value under natural market conditions, derivatives can turn your entire investment into nought in a single trading session. There is complex mathematics involved, which in the right hands gives rise to strategies which can exploit market volatility to mint loads of money.

So if you are willing to take the risk, and invest the time to read up about derivatives, learn the pricing models, develop a knack for understanding how volatility plays a crucial role in derivatives, I would suggest you try trading in derivatives with a small base.

If all of these seem to be outside the purview and possibility of your everyday life, kindly steer clear. It is for your own good.

Okay! So now you broadly know the different investment instruments that are available in the open market. In the next few articles, we will cover how a mutual fund used a combination of these instruments to sell a unit of it to you, the individual investor. We will also try and learn how you can emulate the same and create your own diversified portfolio.

Happy investing!

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