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Every person, regardless of his age and stage of the life, needs to invest his surplus money. Keeping the money idle in the bank account would lead to its steady devaluation because of inflation. However, one needs to be extra-careful while investing one’s hard-earned money, as choosing wrong investments may generate lower than expected returns or even negative returns.
Risk is inherent in any financial investment. The extent of the risk varies depending upon the nature of the investment. Every person’s risk appetite is also unique. Some people are ready to take risks while some others are risk averse. The risk appetite also varies depending upon the stage of life. Thus, young professionals would typically be more risk-tolerant as they can re-earn money even if their investments go bad, while the retired individuals would be risk-averse, as they need to preserve their savings. The goal of any financial investment process is thus to maximize the returns for a given level of risk appetite.
This background helps any financial planner in deciding investment type and horizon for his clients. Normally, the following investment classes are considered for most of the individual investors:
Term deposit facility is available in all the banks. One has to commit his funds for the specified duration to get a fixed return. The term deposits in large banks are normally safe. However, if inflation is more than the interest rate, then value of the money reduces in real terms. Many private sector companies also offer term deposit facility and pay higher interest than banks. However, one needs to ascertain their track record and the credit rating before taking any decision.
The corporate bond market is liquid only in developed countries while it’s still at nascent stage in developing countries. The bonds pay annual coupon (just like interest) at a fixed rate and the principal is repaid after the maturity. In that sense, they are similar to the term deposits. However, the face value of the bond decreases (increases) as the interest rates increase (decrease). Therefore, they are riskier than the term deposits.
Investing in equity shares of a company entitles you to the proportionate ownership in the company. The share price will fluctuate depending upon the company’s performance and financial results. Equity shares can give good returns in booming economy. However, they can also result in capital erosion in case of recession or poor performance of the company. It is a thumb rule to invest (100 – you age)% of your money in equities. Thus, if you are 30 year old, you can invest up to 70% of your money in shares, while a senior citizen of 65 should restrict the equity investments to 35% of his total funds.
Gold is a good investment when inflation is running high. Traditionally, it is considered as safe haven for investors. One can invest 5-10% of his money in gold depending upon the specific case.
Real estate, like gold, is a good investment in high inflation period. Real estate prices are often uncorrelated with share market and thus diversify one’s risk. One can invest in residential apartment or land or even shop. However, one needs to select the investment carefully, as the returns from real estate are mostly from appreciation of the property. Normally, the upcoming towns and outer sub-urban areas of metro cities are good for capital appreciation. One also needs to verify whether the title of the property is clear to avoid any hassles.
The final investment decision depends on the case and specific investment suggestions shouldn’t be given without knowing the investor well. However, it may be said that a proper mix of various investment classes should be selected so as to achieve diversification and maximize return.
Kapil Edke writes about investments, stock markets, self-development, philosophy and miscellaneous topics.