It is important to understand the basics of the investing process before you start investing. To understand the fundamentals of investing, browse through the various sections of the tab. The sections aim to avoid jargon for the terms associated with investing that help you make informed investment decisions. After all, it is important that your hard-earned money grows by investing.
A. Saving is the amount of money set aside by you for future use. The immediate use of money is forgone to accumulate a fund over a period of time. This reserve money is used to meet expenses like children's education, buying a house, for marriage etc. in the future or other contingency requirements.
Q. What is investment?
A. Investment is money used to purchase securities, buy a scheme, or assets where there is an element of capital risk involved but the scope for incremental returns is higher. It's important to note that money set aside on a regular basis, i.e. savings, carry a limited risk of cash devaluing due to inflation. On the other hand, investments carry a risk of capital loss, but come with a promise of surpassing the nominal returns provided by 'savings instruments' and inflation thus providing actual growth in value.
Q. Why is it important to invest?
A. The objective of investing is to help your money grow with time as the real value of money is likely to reduce in the future due to a phenomenon called inflation (i.e. a rise in the general level of prices of goods and services in an economy over a period of time).
Let us explain the importance of investing by way of an example. Assume that your financial goal is to accumulate Rs 10,00,000 at the end of 5 years. To achieve this goal, you would have to set aside an amount of Rs 2,00,000 every year.
However, if you put an amount of Rs 2, 00,000 per annum in a most basic mode of investment like an investment vehicle which has returns of say 10%, it would earn you interest (10% in this example). By investing your money, you would be able to achieve your financial goal in 4 years itself.
Thus, investing your money is a wise choice as it helps you achieve your financial goals much faster.
Q. When should I start investing?
A. There is no ideal age to start investing. The thumb rule is: "The sooner the better." Starting a few years earlier can make a lot of difference to the amount that gets saved. This is because you start to earn not only on the principal but also on the interest from past years through a mathematical phenomena called compounding (interest calculated not only on the initial principal but also the accumulated interest of prior periods).
Let's take an example to understand how the concept works. Let's assume Mr. X starts to invest Rs 1,00,000 per annum at the age of 35 years. For example if the rate of interest is 8% at the age of 60 years, he would have Rs 79,00,000 in his retirement corpus. On the other hand, if Mr. Y starts to invest the same amount every year at the same rate of interest when he is 25 years old, he would have Rs 1,86,00,000 in his retirement corpus.
Further, the gap keeps increasing if the rate of returns is higher during the time of investment. For instance, if the rate of interest is 15%, then at the age of 60 years Mr. X would have Rs 2,44,71,197 while Mr. Y would have Rs 10,13,34,568.
Thus we can see that it's not only important to start investing at the early age but also vital to select the right mode of investment to enjoy a higher growth rate during the investment tenure keeping in mind your needs and appetite for risk.
Q. What are the different types of asset classes available to an investor?
A. The following are the various asset classes available to an investor:
Investing is a trade-off between risk and expected return. Depending on the risk appetite of an individual, he can choose to invest in a combination from the above mentioned asset classes that would optimize his returns.
Equity (also known as a stock or share) is a portion of the ownership of a company. A share in a corporation gives the owner of the stock a stake in the company and its profits. As the individual buys more stocks his ownership stake in the company increases.
Stocks are relatively more risky. Along with providing an opportunity to earn significant returns, they also carry the risk of loss of the invested amount.
A bond is a formal contract that obligates the borrower to repay the borrowed money with interest to the issuer of the bond. In India, the corporate bond market mainly consists of issuers of three different categories - government-owned financial institutions (FIs), government-owned public sector undertakings (PSUs) and private corporate entities.
/ Real Estate
Recently, investing in real estate has become increasingly popular making it a common investment vehicle. Although the real estate market has plenty of opportunities for making significant amounts of money, real estate as an asset class is not readily accessible to the retail investor. However, with the introduction of real estate mutual funds (REMF), investors across various sections of the society will be able to take advantage of the growth in this sector.
Of all precious metals, gold is the most popular as an investment. It is renowned as a hedge against inflation and has limited downside risk.
Q. What are the basic principles of investing?
A. Financial planning needs to be undertaken according to an individual's financial goals. However, it is advisable to adhere to the following basic principals while investing in order to minimize the downside risk of a portfolio.
Diversification is the key to minimizing risk in a given portfolio. This is because all the asset classes do not move in the same direction at the same time. It is therefore advisable to spread investments across asset classes.
Along with diversification, asset allocation is an important principle to follow while investing. Asset allocation is the strategy used to determine the proportion of investments made in each asset class that solely depends on the risk appetite of an individual. Asset allocation helps in reducing the overall risk of a portfolio as all assets perform differently at a given point of time.