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How to make the best of your savings
Kairav Shah in Mumbai | March 13, 2007 12:11 IST
In other words, investment is 'the act of committing money or capital to an endeavour with the expectation of obtaining an additional income or profit.'
Essentially, it's a different way to think about how to make money. Of course, to decide which investment vehicles are suitable for you, you need to know their characteristics and investing objective. Debt market, bonds, mutual funds, equities, insurance, cash, gold, real estate and home loans.
Investing is a conscious decision to set money aside for a long enough period in an avenue that suits your risk profile. The options for investing our savings are continually increasing, yet every single investment vehicle can be easily categorised according to three fundamental characteristics - safety, income and growth - which also correspond to types of investor objectives.
While it is possible for an investor to have more than one of these objectives, the success of one must come at the expense of others. Here we examine these six types of objectives, the investments that are used to achieve them and the ways in which investors can incorporate them in devising a strategy.
Such securities are arguably the best means of preserving principal while receiving a specified rate of return. The safest investments are usually found in the money market and include such securities as Treasury bills (T-bills), certificates of deposit, commercial paper or bankers' acceptance slips; or in the fixed income (bond) market in the form of municipal and other government bonds, and in corporate bonds.
It is important to realise that there's an enormous range of relative risk within the bond market: at one end are government and high-grade corporate bonds, which are considered some of the safest investments around. At the other end are junk bonds, which have a lower investment grade but possessing more risk than some of the more speculative stocks
For example, if there was a 6 per cent inflation rate for the extra 20 years, a Rs 100 purchase today would cost Rs 321 in 20 years. Remember to look at an investment's 'real' rate of return, which is the return after inflation.
The aim of investments should be to provide a return above the inflation rate to ensure that the investment does not decrease in value. For example, if the annual inflation rate is 6 per cent, then the investment will need to earn more than 6 per cent to ensure it increases in value.
This is the inverse relationship between safety and yield: as yield increases, safety generally goes down, and vice versa. Most investors, even the most conservative-minded ones, want some level of income generation in their portfolios, even if it's just to keep up with the economy's rate of inflation.
But maximising income return can be an overarching principle for a portfolio, especially for individuals who require a fixed sum from their portfolio every month.
Growth of Capital
Blue chip stocks, by contrast, can potentially offer the best of all worlds by possessing reasonable safety, modest income and potential for growth in capital generated by long-term increases in corporate revenues and earnings as the company matures.
Making contributions to an IRA or other tax-sheltered retirement plan can be an effective tax minimisation strategy. By far, tax-saving is the most compelling reason for investors to set aside money for the long term.
Each of these vehicles has positives and negatives. The point is that it doesn't matter which method you choose for investing your money, the goal is always to put your money to work so it earns you an additional profit.
If an investor desires growth, for instance, he or she must often sacrifice some income and safety. Therefore, most portfolios will be guided by one pre-eminent objective, with all other potential objectives occupying less significant weight in the overall scheme.
Choosing a single strategic objective and assigning weights to all other possible objectives is a process that depends on factors like the investor's temperament, his stage of life, marital status, family situation etc. Even though this is a simple idea, it's the most important concept in the current scenario to understand.