Investment Landscape

Investment Landscape (Part 1)

Saving and Investment: Saving and investment are two different concepts. Saving refers to the reduction in the amount of money used, while investment involves putting money into something with the expectation of earning a profit.
Key differences: The primary objective of saving is to keep money safe, whereas the primary objective of investing is to earn profits. There is a trade-off between risk and return.
Evaluation factors: When evaluating savings and investment products, consider the following factors:
- Safety: The safety of capital invested and the degree of surety of income from investment.
- Liquidity: How easily can one liquidate the investment and convert it to cash?
- Returns: The major purpose of investment is to get some returns, which may be in the form of regular income or capital appreciation.
- Convenience: The ease of investing, taking money out, and checking the value of the investment.
- Ticket size: The minimum amount required for investment.
- Taxability of income: What one retains after taxes is what matters, and hence, taxation of earnings is an important factor.
- Tax deduction: A related matter is the tax deduction that may be available in case of certain products.

Asset classes: Various investment avenues can be grouped into categories called asset classes. An asset class is a grouping of investments that exhibit similar characteristics.
Four broad asset categories:
- Real estate: Considered the most important and popular among all asset classes. However, it is often purchased for self-occupation rather than investment.
- Commodities: People are familiar with commodities, but it's not possible to invest in most of them due to perishability or storage difficulties. However, commodities like gold and silver can be invested in.
- Fixed income: Involves borrowing money and paying interest on the amount borrowed. Examples include bonds and debentures.
- Equity: The owner's capital in a business. Someone who buys shares in a company becomes a part-owner of that company.
Characteristics of each asset category:
- Real estate: Location is key, illiquid, not divisible, can generate current income, and has high transaction costs.
- Commodities: Prices are almost in sync across the world, but investing in commodities like gold and silver only provides capital appreciation, not current income.
- Fixed income: Generally considered safer than equity, but not totally free from risks. Examples include bonds and debentures.
- Equity: The owner's capital in a business, with the potential for high returns, but also higher risks.

Equity Investing: Historically, equity investing has generated returns in excess of inflation, increasing the purchasing power of one’s money over the years.
Risk Capital: Equity shares represent risk capital, as the owner’s earnings are linked to the fortunes and risks of the business.
Dividends: Equity share owners may receive dividends from the company, which are shared out of the profit generated from business operations.

Equity and Bonds: Investments in these assets can only be done in financial form.
Real Estate and Commodities: These assets can be bought in both financial and physical forms, providing a sense of safety due to their tangibility.
Investment Purposes: Real estate and commodities can be bought for investment or consumption purposes, such as renting out a property or buying gold for personal use.

Ownership Assets: Investors in equity, real estate, and commodities are owners of the asset, with uncertain future returns.
Lending Assets: Investors in bonds have lent money to someone, with agreed-upon interest payments and return of principal amount.
International Assets: Investments can be made in assets denominated in various currencies, exposing the investor to currency fluctuations.

Table 1.1: Illustrates the classification of investment avenues under different asset categories, including equity, fixed income, real estate, commodities, and hybrid asset classes.

Four Basic Needs: Transaction needs, protection needs, investment needs, and retirement needs.
Transaction Needs: Met through the banking system, involving day-to-day transactions such as income and expenses.
Protection Needs: Met through life and health insurance, providing solutions for financial difficulties due to death or health issues.
Investment Needs: Met by investing regular monthly surpluses in investment products to fund expenses and goals.
Retirement Needs: Funded through savings and investments accumulated during the working life, with a different approach required for the preretirement and postretirement phases.

Goal Setting: Identifying events in life, assigning priorities, and determining the timeline and amount of funding required.
Classification of Goals: Based on the timeline, such as short-term needs versus long-term goals, and the importance of the goal, such as critically important or good-to-have.
Inflation Adjustment: Critical for planning, as the cost of goals is likely to increase over time due to inflation.

Inflation Impact: The cost of education and other expenses can rise significantly over time due to inflation, making it essential to consider inflation when planning for long-term goals.
Inflation Calculation: If the inflation rate is 6% p.a., the household expenses would increase by 6% each year, resulting in a substantial rise in expenses over time.
Example: A family's monthly expenses of Rs. 30,000 would increase to Rs. 31,800 in a year and Rs. 53,000 in 10 years, assuming an inflation rate of 6% p.a.

Definition: A mutual fund is a professionally managed investment scheme that allows individuals to outsource their investment management to a team of experts.
Benefits: Mutual funds provide a convenient way to invest in various assets, reducing the need for individual research and administration.
Comparison with Self-Investment: Investing through mutual funds may be more beneficial than managing investments oneself, considering the time and expertise required.

Ability to Manage Investments: Individuals may not have the necessary skills or time to manage their investments effectively.
Desire to Manage Investments: Even if individuals have the ability, they may not want to spend time on investment management, preferring to focus on other activities.
Cost of Outsourcing: Mutual funds come with management fees, but these costs should be weighed against the potential benefits of professional management and the hidden costs of self-investment, such as time and potential mistakes.

Time Cost: The time spent on research, administration, and accounting can be significant, and its value should be considered when evaluating the costs of mutual funds.
Mistake Cost: Emotional attachment to one's finances can lead to mistakes, which can be mitigated by professional management through mutual funds.