Personal investments - Some insights

Investment is to make money work and generate as high returns as possible.  Investors, both individual and institutional, are always on the look out to identify best investments that meet their expectations. In respect of individuals, investments also improve the habit of thrift, regarded my many as a virtue. Hence, individuals who save money to make investments can achieve the cherished twin objectives of being responsible in their spending styles and making the money to grow for the rainy day.

There is a wide spread misnomer regarding investments that they empty the pockets of a common man. This argument of many does not hold water. All of us appreciate that 'Known devil is better than an unknown angel'. In the similar fashion, everyone shall try to gain knowledge about investments so that they can use it as an investment opportunity rather than fearing of it.

Investments can be made in a wide range of avenues like real estate, shares and bonds of listed or unlisted companies, precious metals like gold, platinum and silver, commodities, derivatives, mutual funds, National Savings Certificates (NSCs), units of UTI, savings or time deposits in commercial banks, money market instruments etc. This list, by any stretch of imagination, is not exhaustive.

Investments can be made directly by an investor or there are indirect investments where investors give money to fund managers (who on their behalf invest in one or more of the investments stated above. Most of the investors may not have the necessary technical knowledge or time to make investments on their own.  This explains the recent spurt in the demand for fund managers.

Investment style varies from individual to individual. Most of the investments that individual investors make are on the basis of views or opinion of themselves, their relatives, friends etc.

Some investors prefer to have a wide variety of investments in their portfolio in their quest to diversify away the concomitant risks. However, at the same time, there are many investors who limit themselves to a handful, thus increasing unknowingly the risk.

In addition to this, investors differ from one another with respect to their attitude towards risk. Some investors are risk averse while others are risk seeking.  Those with higher risk appetite need to be rewarded with higher returns in order to be motivated for making investments with relatively higher risk.

In this article, I would like to highlight various parameters to be considered by an investor while selecting investments. Investors may be institutional investors or individual investors. The latter for a variety of reasons do not have an in depth knowledge and hence end up losing significant amounts of hard earned money.  I am therefore inclined to focus on factors to be considered by individual investors while making fortune-changing investment decisions.

Factors Influencing Selection of investments

Primary criteria to be considered while making an investment are risk and return, which are directly related. However, there are certain other parameters like holding period, initial investment, Tax benefits etc which are to be given due importance in the selection of investments.

1. RISK

Risk is the most key parameter to be considered while making an investment. Risk involved in the investments is the risk that investor ends up on the downside of the investments i.e. losing money, if not making return out of it.

Risk involved in Investments emphasizes the need for Diversification. This has given rise to famous investment adage “Don’t place all your eggs in the same basket.” Investors should appreciate that placing all the eggs in a single basket is not advisable. It may even change fortunes overnight, should something go wrong.

Based on the attitude towards risk, every individual investor should try to take calculated risk by having a well-balanced portfolio.

2. RETURN

Return is reward for risk and sacrifice made by an investor. It is the basic yardstick that every investor uses to measure the performance of an investment. Return is expressed in annualized terms in order to achieve comparability. Return on Investment (ROI) may be directly available by way of coupon rate (in the case of bonds and other fixed income securities). Return is generally realised to an Investor in the form of Capital Gains or regular income.

We all appreciate that Risk and Return are directly related.

However, quite often, we see the cases where investors get carried away by the sheer size of return. Just because an Investment is generating high return, it is not considered to be the best one. A less risky investment giving decent return is far better when compared to a risky investment generating high return.

3. FINANCIAL OBJECTIVE

Financial objective of an investor may be for their child’s education, marriage, for housing etc. It differs from investor to investor.

Also, regular income becomes a requirement for many investors. Hence, it will affect the investment pattern of an individual.

Investment that a person makes must suit his attitude. A risk-averse individual going for risky investment may result in him ending on the wrong side.

4. HOLDING PERIOD

Holding period of the investment in turn depends on the financial objective of an individual investor. Holding period differs from person to person. Some investors will invest in stocks and hold it for one day whereas others may hold it for a long period of time. Time even determines the amount of benefits that may accrue to an investment. Matching the investment holding period with the financial objective is key for any investor.

5. TAX BENEFITS

Effect of an investment on one’s tax liability shall also be considered while making an investment. Investments are made out of consumable income by sacrificing present consumption. Return from all the investments may not be generated in the year of investment only. Hence, individual investors would prefer those investments where they will not get affected twice i.e. once by virtue of investment outlay and other time by way of tax.

6. INITIAL INVESTMENT

Initial investment to be made for an investment plays a dominant role in enlisting various choices available to an individual investor. Even though, investment avenues like real estate give very high return, they are not open to all as they involve very high initial investment. Also, putting in high amount of investment results in increased risk with respect to the investment.

7.       EXISTING INVESTMENTS

Existing investments made by investors also influence the future investments. It involves even the experiences of an investor with respect to any investment. If an investor already has an investment in a risky one, it would be advisable for him to go for a less risky investment so that his portfolio will have a balanced risk.