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What is Investment?

dateKnowledge Centre Team dateFebruary 21, 2023 views459 Views
Investment Meaning | Investment Strategies

The meaning of investment is putting your money into an asset that can grow in value or produce income or both. For example, you can buy equity stock of a listed company in the hopes of receiving regular dividends and capital appreciation in the form of the share price.

Your savings become investments when they are put into assets that carry investment risk or a degree of illiquidity. Such investments help you create wealth that can be used as an emergency fund, a retirement corpus, for buying a house, or funding a child's education, etc.

Objectives of Investment

The need for investment will grow as you move ahead in life. Growing responsibilities will demand an increase in investment. The primary objectives of investment are listed below:

  • Safeguard your Money

    Investing keeps your money safe from immediate and unnecessary expenditures. It also helps you keep your money safe from inflation effects. Inflation erodes the value of your money unless it is invested in an interest-earning asset. Thus, investing will help you automatically keep up with inflation.

  • Grow your Savings

    Investment is the only way to start growing your invested money. It allows your money to earn interest and if you keep the interest invested it will also start to earn interest.

  • Build Funds for Emergencies

    Life is usually a series of ups and downs. Few times you are earning decent and saving money while other times you need a large sum for an emergency. Building investment pools help you on such rainy days.

  • Secures your Retired Life

    Retired life is where you don’t have a source of income to sustain your life. Once you have built a retirement corpus, you can experience the freedom that comes with it.

  • Save Tax

    Investment in tax-saving instruments like life insurance plans, ULIPs, PPF, NPS, etc allows you to claim deductions on your taxable income. Thus, investing in specific assets can help you reduce your tax liability. Many of these investments also help you reduce your future tax with tax-free maturity values.

  • Fund Bigger Life Goals

    Your monthly income will not be enough to purchase your next car or build a house for your family. However, if you invest a small sum in a few years both could be possible.

Different Categories of Investments

Depending on the type of asset you invest in you can expect a certain degree of risk and return ratio. You can divide all investments into the following categories:

  • Owner's Equity

    These are some of the high-risk investments as you are directly holding the ownership stake. Owners only earn after paying all the expenses and liabilities. Ownership stake makes you a party to the profits and losses of the company.

  • Lending

    Lending is considered safer than equity ownership as you secure an obligation from the borrower to pay interest. Thus, you hold the first right to the money over the owners. However, the rate of return will also be lower.

  • Money Market Participation

    Money market investments are short-term debt obligations, which can last up to 365 days or less. Examples include T-bills, Commercial Papers, etc. Even though these investments will earn less, they are safe.

Types of Investments

You will find many investment options and you should shortlist the best ones as per your needs. At a broader level, investment can be divided into two categories - Equity and Debt. Equity primarily invests in shares of companies in different ways. Debt is where your money is invested in money market instruments.

The below table lists different types of investment options in India:

Investment Type Description Risk Reward
Stocks Stocks represent your ownership share in the company. Stocks will provide a return on investment through changes in the share price, or dividends. It can be highly volatile and is considered one of the riskiest investments. High High
Bonds Bonds are an instrument of borrowing. Bondholders have the first right to the assets of the company. Thus, these are considered safer than equity stocks. Also, a bondholder’s return on investment will be more stable than a stockholder's as bonds can have fixed coupon rates. Low Low
Mutual Funds Mutual funds are pooled assets that are professionally managed. It can pool money from thousands of small investors and create a portfolio of up to 30 securities to generate a return on the pooled money. Mutual funds allow investors to invest a small amount regularly and choose their asset portfolio as per their risk profile. Medium Medium
Unit Linked Insurance Plans ULIPs are life insurance plans that allow you to invest in diversified funds as per your risk profile. You will get market-linked returns and tax-saving benefits on your investments. Life cover will be available regardless of the performance of the invested sum. As per your portfolio High
Gold Investing in physical gold could be expensive, risky, and fraught with storage issues. Thus, you can use an electronic form of gold investment. Gold ETFs and Gold Bonds are some of the popular ways of investing in gold and keeping up with its price. Medium Low
Public Provident Fund (PPF) It is a scheme that offers a good rate of return and a sovereign guarantee. With PPF you can beat inflation, and build handsome wealth, that too completely tax-free. PPF also allows adequate liquidity. Thus, this investment helps you build a safety fund for your family. The account is extendable after 15 years of maturity. So, you can use it to save for your retirement and draw a tax-free pension after 60. Low Low

Why is your Choice of Investment Asset Important?

Selecting an investment option needs a balance between the following three factors:

  • Liquidity
  • Risk or Volatility-Return
  • Investment Tenure

Usually, risk-return and liquidity are inversely proportional to each other. The higher the risk the lower the liquidity and the higher investment tenure you will need.

For example, if you are only saving money, the liquidity is high, the investment risk is zero, and there is no investment tenure.

All the assets and investment options offer a different trade-off between these factors:

Investment Option Liquidity Risk-Return Ideal Investment Term
Savings Account Equal to Cash Almost Nil Nil
Fixed Deposit Lower than Savings Higher than Savings 7 days to 10 years
Gold High Medium 5 to 15 years
Equity Stocks High Very High 3 to 30 years
Equity Mutual Funds Medium to High High 5 to 10 years
ULIPs Low Medium to High 5 to 81 years
Public Provident Fund (PPF) Low Low (but tax-free) 15 years+
Real Estate Very Low Medium 10 years+

While investing you should always optimize the investment horizon. Your chances of receiving better returns will be higher if you stay invested for a long time with high-risk investments. However, you also need less risky and more liquid investments to fulfill your short and medium-term needs.

Before investing in an asset, you must understand the risk-reward equation and liquidity.

Factors to Consider Before Investing

Now that you understand investment basics, you must also learn to choose the best investment option as per your financial goals. Listed below are a few steps to help you find the best investment option as per your life goals:

  • Define your Investment Goals

    Every financial journey is different, and hence everyone's investment goals are different. The first thing you can do is define your investment goals. This will help you with the following:

    • How much money do you need in the future?
    • How much you can invest now?
    • How long do you need to invest?
  • Choose Investment Options as per Goals

    Once your goals are defined, select the investment option. Your choice will depend mostly on the time available for a particular milestone or event in life. For example:

    • If your goal is to buy a car after 3 years, you can invest your savings in a debt mutual fund and achieve your goal.
    • Buying a house after 10 years means you can invest in equity funds and stocks.
  • Ensure Higher Tax Savings

    Long-term investment options can also help you save on tax:

    • Investments like PPF and ULIPs help you reduce your taxable income when you invest in them.
    • Equity mutual funds, gold ETFs, and debt mutual funds enjoy indexation benefits on capital gains if you hold them long enough.
  • Insure Important Family Goals

    Certain family goals like a child’s higher education and marriage cannot be left to chance. So, you should choose investment options that offer good growth as well as protection for the goal.

    • Investment options like ULIPs have a life insurance cover with diversified investment options.
    • Guaranteed Return Plans are safe long-term investments that offer guaranteed returns on the investment that you make.

Investment is essential to grow your money and create wealth. It will help you achieve your life goals. There are many investment options available in India, and you must understand the purpose, the risk, and the reward associated with them.

You should pick an option according to your investment goals and needs.

FAQs Related to Investment

Investment is an activity of exchanging money for an asset. The asset can be real, legal, or virtual, but such assets will have a value that will vary over time. For instance, paintings, equity shares, bonds, NSC, etc.

You can invest for a specific purpose, i.e., to safeguard money, to buy a car, to build a retirement fund and you can choose your ideal investment asset. For example, safekeeping requires high liquidity or tax saving. But retirement would need less liquidity but a high rate of return such as ELSS or ULIPs.

You should start investing as soon as you start earning or even sooner if possible. Money creates more money, and the sooner you begin to work, the better. So, investing early will allow you to accumulate wealth faster and free yourself from financial worries.

Growth of your money depends on the investment risk you can take. Saving suffers from the following two risks -

  • It doesn’t provide growth
  • The value of your money will decline due to inflation and taxes. Also, habitually, we end up spending the available money.

Thus, investing keeps the savings safe from inflation, and expenditure.

Disclaimer: This article is issued in the general public interest and meant for general information purposes only. Readers are advised to exercise their caution and not to rely on the contents of the article as conclusive in nature. Readers should research further or consult an expert in this regard.

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