There is lots of uncertainty in life as well as the economy. Throughout our life we earn and spend. Sometimes our expenses are more than our income which lead to borrowing and debt, where as sometimes our income is more than our expenses which leads to savings. The basic idea to save is to use it when we have a deficit in our cash flow. To ensure that the savings grows well to take care of our future dreams, it is very important to plan investments.
Good investment planning can turn our goals from dreams into realities. This planning involves more than trying to pick the "right" investments. How you allocate your money among different types of investments can have a greater effect on investment success than the individual investments you choose. So, your first step in investing toward your goals is to work out an asset allocation for your investments. However, it is very important to understand the purpose of investments. As our short term goals need to be taken care by short term investments. For this we can't invest in real estate or properties as these need some time to grow.
We also need to understand that al that we purchase out of our surplus is not investment. At one place where we say that real estate is an investment, we can't say the same when we buy a property for our use. Like for example, buying a house is a real estate deal but is not an investment, if consumed. Buying a car is not an investment, unless it's a vintage car and is bought for the purpose of selling at a higher price because of being an antique. Similarly investors in art & paintings invest with a motive of selling such item at a higher price because of its creativity and imaginative presentation.
Thus we can term investment as an asset or item that is purchased with the hope that it will generate income or appreciate in the future. In an economic sense, an investment is the purchase of goods that are not consumed today but are used in the future to create wealth.
Besides this option we have another most popular tool of investments i.e. investments in stocks and its derivatives. These investments are then expected to provide income or positive future cash flows, but may increase or decrease in value giving the investor capital gains or losses. Trades in derivative securities do not necessarily have future positive expected cash flows - so are not considered to be assets, or strictly speaking, securities or investments. Nevertheless, since their cash flows are closely related to (or derived from) those of specific securities (underlying asset), they are often studied or treated as investments.
India is a growing economy and there fore is attracting more and more investments as the as savings are also growing. GDS is currently about 30% of GDP. Discussed below are the investments options which are prevailing or taking a shape.
I. Small Savings
There are various schemes under small savings. The basic is the savings bank account which gives a very uncompetitive return. Besides this there are the post office schemes available in the market. These are fixed basically fixed income securities which are managed by Post Office. The various post office savings scheme (POSS) can be discussed below:
National savings certificate (NSC) is an assured return scheme held physically in the form of Certificates issued to the investors by the post office. Interest is payable at 8%, compounded half-yearly for a duration of 6 years. The scheme offers a coupon of 8%, compounded semi-annually. So, Rs.1,000 invested in NSC becomes Rs.1,586.87 on maturity after 6 years. NSC is issued in denominations of Rs.100, Rs.500, Rs.1,000, Rs.5,000 and Rs.10,000. There is no prescribed upper limit on investment in NSC.
Kisan vikas patra (KVP) doubles the money in 8 years and 7 months with the advantage of premature withdrawal. KVP is sold through all Head Post Offices and other authorized post offices throughout India. The rate of return is 8.41%, compounded annually. Interest rates affect the decision to buy, hold, or sell (encash prematurely) relating to KVP. The Government of India has reduced the interest rates on KVP and other post office schemes in the Budget 2003-04. The minimum investment in KVP is Rs.100. Certificates are available in denominations of Rs.100, Rs.500, Rs.1,000, Rs.5,000, Rs.10,000 and Rs.50,000. The denomination of Rs.50,000 is sold through head post offices only. There is no limit on holding of these certificates. Any number of certificates can be purchased. A KVP is sold at face value; the maturity value is printed on the Certificate. Although no TDS is applicable on the interest income from KVP, there are no tax incentives in KVP.
Monthly income scheme (MIS) provides for monthly payment of interest income to investors. The duration of the MIS is six years. The post-office MIS gives a return of 8% plus a bonus of 10% on maturity. However, this 10% bonus is not available in case of premature withdrawals. It is meant to provide a source of regular income on a long-term basis. The minimum investment in a Post-Office MIS is Rs.6,000 for both single and joint accounts. The maximum investment for a single account is Rs.3 lacs and Rs.6 lacs for a joint account. These are also held physically in the form of a certificate issued by the post office.
Recurring Deposit Account (RDA) is akin to a Recurring Deposit in a bank, where you invest a fixed amount on a monthly basis. The deposit has a fixed tenure, and the scheme is a powerful tool for regular savings. As the name says, the RDA is a systematic way of saving money. Recurring Deposits accumulate money at a fixed rate of interest (currently 7.5% per annum), compounded quarterly, and your investment appreciates in five years. The scheme is meant for investors who want to deposit a fixed amount regularly, in order to get a tidy sum after five years. The minimum investment in a post-office RDA is Rs.10. There is no prescribed upper limit on your investment. If you invest Rs.10 every month, you will get back Rs.728.90 after 5 years. A post-office RDA can be opened at any post office in the country by filling up the appropriate forms.
II. Bonds (Fixed Income Securities)
Bonds are the basic form of fixed income security. It is issued by a borrower (borrowing company) to the lender (the investor). The bondholder receives coupon payments at periodical intervals say annually, quarterly or semiannually and the redemption amount on the maturity date.
e.g.: An individual invests Rs.1,000 in a bond that pays interest at the rate of 10% semiannually, he/she can expect to receive Rs.50 semiannually (i.e., 10% x 1000 x 0.50) and at the maturity he/she will recover Rs.1,000, if the bond is redeemed at par.
Sometimes, bonds are issued as zero coupon bonds where no interest is paid to the investors. Instead, these bonds are issued at a discount to the face value and are redeemed at par.
e.g.: A bond with a face value of Rs.10,000 may be issued at a discounted value of say Rs.8,500. The bond would be redeemed after, say, 10 years and at that time the investor would get Rs.10,000.
There are long term securities here like government securities (Gilts), debentures and bonds and short term securities like call money market, repos, treasury bills, commercial papers, commercial bills, forward rate agreements and interest rate swaps.
III. Equity Shares
Equity shares are the most common form of company security and most popular among the investor. As the name suggests, the holder of such security is owner of the security to the extent of his exposure. They have the right to vote and receive any profits in the form of a dividend. These are highly liquid securities traded on the exchange. The risk involved is also high in these types of securities.
However, equity shares are not the only form of securities that a company offers. Besides this there are others like preference shares, warrants, bonus issues and right issues.
Preference shares are those which get a preference over the ordinary share holders in getting the dividend but at a fixed percentage but after paying the interest on debentures. There are different kinds of preference shares. They are cumulative preference shares, participating preference shares, redeemable preference shares and convertible preference shares.
Warrants are an added feature by the company which generally attached with the fixed income securities. Warrants are also traded on the exchanges at times.
Bonus issues are also ordinary shares issued to the existing share holders of the company in prorate or other arrangements. This is also done to reduce the price of the shares without reducing the value of investments of the shareholders.
Right issues are a right to the share holders to purchase fresh shares of the company with a price benefit.
IV. Mutual Funds
Mutual funds are professionally managed portfolios. They are a pool of money where investor with a common objectives and goals put their money. Mutual funds have the required expertise to manage the portfolio and are also guided by the regulators to manage such portfolios in the best interest of the investors. Investment in stocks, bonds and other financial instruments require considerable expertise and constant supervision so as to be able to take informed decisions. Small investors usually do not have the necessary expertise and the time to undertake any such monitoring that can facilitate informed decision-making. This is the predominant reason for the popularity of mutual funds.
Most of the mutual funds issue and repurchase the shares at a price that reflects the underlying value of the portfolio at the time of transaction. This price is known as net asset value (NAV).
Mutual finds are of two types namely close-ended mutual funds and open-ended mutual funds.
Close-ended mutual fund schemes have a stipulated maturity period wherein the investor can invest directly in the scheme at the time of the initial issue and thereafter units of the scheme can be bought or sold on the stock exchanges where the scheme is listed. Open-ended schemes usually do not have a fixed maturity period and are available for subscription and redemption on an ongoing basis. The units can be bought and sold any time during the life of the scheme at NAV related prices.
There are various kinds of mutual funds like equity funds, balanced fund, and debt funds primarily. They are:
- Equity Funds: The funds those are invested in stocks market primarily are equity funds. It should be invested more than atleast 60% in equities.
- Balanced Fund: Balanced funds are a mix of equities and debt instruments. These schemes have are invested in both depending upon the fund objectives.
- Debt Funds: Debt Funds, again, as the name suggests should be primarily invested in debt securities, other approved government securities, approved papers issued by corporates and also in fixed income securities.
- Floater Funds: Will invest predominantly in Floating Rate Debt Instruments and money market instruments and in fixed rate debt securities.
- Equity Linked savings Scheme (ELSS): A special product offered by mutual funds. These schemes invest in equity i.e. shares and generally have a lock-in period of three years. The basic feature of ELSS schemes is that it is tax efficient under 80L of The Income Tax Act.
V. Insurance based Investments
Insurance, however, has also become as an investment with various product hitting the market with over 20 private players in the market. These can't be termed as pure insurance products but are a blend of insurance as well as investments. Insurance based investments have become very popular these days as they fetch good returns and are tax efficient also. This avenue will be discussed in detail in the Insurance module (HYPERLINK).
VI. Derivatives
Derivatives are products whose value is derived from the value the underlying security or asset also known as bases. The underlying can be a commodity, asset, index, shares, foreign exchange currencies or any other. The basic financial derivatives forms are forwards, futures and options.
Forwards contracts are transactions where one party promises to buy a product at a specified price for a specified amount and on a specified future date. This promise is done on a piece of paper formally. Thus it can be said that any transactions which is formally schedule to happen at a future specified date on consensus is a forward contract. Forwards are over the counter transactions and not traded on exchange.
Futures contracts are essentially more organized and standardized forward contracts. Futures are traded on well run exchange. However, in futures, unlike forwards, it is not necessary to take the delivery of the underlying assets. The future contracts, as traded on the exchange, can be bought or sold like shares in the stock market.
Options are options to the buyer of such derived product to buy or sell at the market price. They are bought fro a price called premium. It has a strike price for the security also. It matures at a specified time; in India generally we have three option contracts 1 month, 2 month and 3 month. There are two types of options namely call options and put options.
Calls are an option to buy the security or the underlying from the writer of such option. The buyer has to pay a premium for such option to the writer. Similarly the put option is an option to sell the underlying the security. In India the option are cash settled. They can be bought or sold at any time before the expiry.
VII. Real Estate
Investors can invest in different forms of real estate such as land, flats, independent houses or commercial property. Real estate is not exchangeable and transferable easily. The return from real estate investment can be in the form of rent, capital gains and certain tax benefits. Investors have to consider various factors such as location, design and potential for appreciation while investing in real estate. Among these factors, location is an important parameter because it determines the value of the real estate. It is very difficult to predict the risk and return involved in the real estate market and therefore investors have to consider various factors while investing in real estate.
VIII. Commodities
Commodities are tangible goods that can be used for various purposes. They include all goods and articles except financial assets. In fact, commodities futures and options are contracts to buy and sell goods such as cotton, corn, wheat, coffee and cocoa, silver, oil, etc. The contracts are traded all around the world for various purposes and in various modes in both organized and unorganized markets. The participants in the commodities can be termed as arbitrageurs, speculators and hedgers based on the purpose of their participation.
IX. Bullions
Bullions are also very popular with big investors. Bullions include gold, silver, foreign exchange currencies, etc. In India yellow metal, Gold is a very favorite buy. Gold is very popular among others.
The various avenues here have a different risk return chemistry. Few are highly risky and few of them are very safe. But as we know 'no pain no gain', it is important to understand that higher return comes due to volatility and volatility is nothing but risk, so, higher the risk higher the gain.
However, it can be seen that these products are in different position because of their risk return combination and their size implies their liquidity.
