It is always a difficult decision to make, whenever you want to invest your money. Many a times, we are influenced, in our decision making, by our friends, well wishers and relatives. Sometimes, the investments are emotional and spontaneous.
I thought of putting a structure so that, one can use this as a guideline before making an investment.
I have written earlier about the REF LIST but it is worth while repeating this.
R – stands for Risk involved in the investment. Risk means getting not what you expect. For example if you expect a 10% and get 8% even then the instrument carries Risk. Mostly we are not worried about the reduction in returns, but alarms us when the return is negative. In the above example if your investment instead of generating a positve 10%, the capital is down by 2% , it is a negative risk.
In risk – you must know the risk, willing to take the risk and must have the capcity to bear the risk.
Just see the picture below with the ascending risk levels.
see attachment investment-ladder
Risk and Volatility
There are few instruments which give assured stable returns. Like FDs, NCDs, Government securities.
Any assured income which is paid at the specified rate is deemed as interested and taxed as nominal income. It is added to your total income.
Other returns may not be same, it can vary. The degree of variation is measured as a volatility.
Risk, in equities is there in the short term and generally there is no risk, if invested over a long period of time, say, 7 years and above.
News about any organisation may be increase or decrease the risk and the returns in the short term could be volatile.
E – stands for Exit options. For all investmennts, you must know when you want to exit. If you don’t know this, you may be making a mistake and could lose the capital. If you are investing for a duration of one or two months, you should not be investing in an equity fund. As any volatility in the markets in the two months, could reduce your capital.
Also you must understand if this is closed ended fund or an open ended fund. You cannot exit a closed ended fund or redeem it unlike an open ended fund, as the name implies, it can be redeemed any time.
Next thing you must keep in mind is the penalty or exit load, which you have to pay, in case you redeem before the maturity period or any other period as specified by the instrument.
F- Stands for flexibility. This is a facility for one to add or reduce investment amount to the initial amount invested. If one invests one lakh, he may want to withdraw say only 10 thousand for an emergency and not the full amount and want to put it back.
Also this gives facility for parking unexpected surplus funds like, Bonus, incentives etc to the investments.
L – Liquidty is the time frame you will get credit of funds from the time you redeem or sell your investments. You can close your FDs and get the money credited the same day. In liquid funds, it happens the next day, known as T+ 1 and most of the other funds it is T + 3.
Real estate is very illiquid as you cannot sell it that easily and the get the money. While you can pledge gold easily and take loan, you cannot sell it easily unless you sacrifice on the price.
Closed ended mutual funds can be sold through stock exchange. But they suffer from two important factors, liquidity – ie very poor volumes of trade and more importantly the price.
I – stands for income or the returns we get out of the investments. Though it is said that the higher the risk, higher the returns, it may vary. Your knowledge about variability of returns is important.
IN the picture above, the risk, generally correlates with the income or return positively. It means the higher the risk, the higher the returns.
All of us want the highest returns possible with zero risk and immediately.
S – Safety is denoted with S and normally it is more, if the risk level is low. In the picture above, FD is green in color, because it scores high on safety whereas equity investments are less safe as they are risky in the short term.
T – Tax efficiency of the income. Some returns are taxable, some returns are treated differently and one can get tax effcient return. Given below is an example where debt funds score over FD. This is just ot make one unerstand indexation and not for any thing else
Understand the various investment options available.
Know the investment ladder.
I have mentioned to the extent possible about each instrument using REF LIST
In case you don’t understand this mail, no problem, pick up the phone and call me.