Financial Investments – 11 Most Important Points to Consider

“Financial Investments are not a child’s play” i read it in a book of a very famous investment guru. The term “investment guru” is loosely used in the personal finance space. We have investment gurus of the stock market, real estate, mutual funds, commodities etc. In past as a common investor, i used to get confused whom to follow and who should be ignored. I could not find reliable 360-degree information on financial investments.

In India, all the people around us are also investment gurus. Normally an investor decides on Financial Investments based on the feedback from their relatives, friends, colleagues etc. Two weeks back i conducted a random survey, i checked with my clients and friends on why they are buying a flat in a particular project. Almost 40% replied that because their friend or office colleague has a flat in that particular project. Another 25% bought under family pressure. It is quite surprising that decision related to one of the biggest Financial Investments is taken based on the decision of friends, office colleagues or under family pressure.

One more peculiar observation from my end related to financial investments is the time spent on research or study before making financial investments. Yesterday evening, one of my friends told me over a cup of tea that he has bought a new smartphone. By the way, he was one of the respondents of my financial investments survey. Last year, he bought a flat in Noida because his friend booked a flat in the same project. I asked him what made him buy the smartphone of a particular brand. He told me that he did very thorough research. He spent 5 days on finalizing a smartphone worth Rs 10,000. I asked him how much time he spent to research on financial investments in real estate and stock market worth more than a crore. The answer was “It is not my cup of tea” and he relies on the information from his close circle. I am sure next time he will not discuss financial investments with me :).

As an investor, we should understand that any financial misjudgment can cost us very heavily. There is no universal rule applicable for all or one size fits sizes. Every investor needs different treatment. For example, one of the investment gurus suggests that your exposure in equity should be 100 minus your age. For example, if my age is 40 years then my investment in equity should be 100-40 i.e. 60%. Sounds great but what if my income is not regular or i have 5 dependents on me. Can i follow the suggestion of this investment guru? The answer is BIG NO. Let’s check out 11 imp points to be considered for financial investments. Some of the factors may be interlinked but it is critical to consider them in isolation.

Financial Investments – 11 Most Important Points to Consider

1. Risk Appetite:

Every individual has a different appetite for risk. It mostly depends on their past experience with financial investments. One of the examples is of my relative, she is now totally a risk averse person post suffering significant losses in the stock market. Always remember that risk appetite cannot be infinite till you lose entire wealth. Most of the financial planners suggest that you should exit financial investments in case investment value is eroded to 80%. In other words, after suffering the loss of 20%, it is time to EXIT. Therefore, before making any financial investments an investor should decide on level and quantum of risk appetite. I covered this topic from a different perspective in my post Investment Risk – 5 Imp Factors.

2. Returns:

There are types of financial investments i.e. with (a) Assured Returns and (b) Variable Returns. In recent past, the returns or interest rate of PPF and some other small savings schemes are linked to the govt bond yield. The interest rate of social welfare scheme like sukanya samriddhi account is also variable in nature. Therefore, it will be safer to say that concept of assured return is dead. The Assured and Variable returns are replaced by Least Volatile and Highly Volatile Returns. The debt instruments and small savings schemes are least volatile financial investments. On the other hand, Equity, Gold and to some extent Real Estate are highly volatile in nature. The reason for including real estate in the high volatile list is stagnant or negative returns.

As a thumb rule, an investor can expect risk-free return equivalent to Fixed Deposit Returns. It is currently hovering near 7.50%. This value should be base value. The deviation from 7.50% should decide whether the returns from financial investments are least or highly volatile. A stagnant or NIL return from real estate means a deviation of 7.50% from FD returns, therefore, it means highly volatile returns. Investors should decide the % exposure in the least and highly volatile financial investments.

3. Lock-in Period:

Lock in Period alternatively means liquidity. In other words, how fast, i can liquidate my investment. High-Value financial investments like Real Estate is a peculiar case. Though there is NO lock-in period but it is not easy to sell/liquidate the property. Secondly, the taxation issues weigh heavily on the mind of the investor. We will discuss taxation in next point. The financial investments like NPS and PPF have a longer lock-in period. These financial products are specifically designed for retirement planning. For tax savings purpose, among all the financial investments options available u/s 80C, the ELSS has the shortest lock-in period.

On the other side, Fixed Deposits are booked for a specific period say 2 years. In other words, 2 years is a lock-in period but you can liquidate fixed deposits by paying the penalty for premature withdrawal. This penalty is normally 1% and most of the investors are not aware of the same. As a thumb rule, you should lock your financial investments if and only if you are sure that you will not need the money during lock-in period. Portfolio of some of the investors is highly skewed towards financial investments in PPF, Real Estate etc. These investors may find themselves in a soup in the case of a financial crisis. Therefore, the portfolio should be balanced between liquid and illiquid financial investments with lock-in period.

4. Taxation:

Taxation is an important aspect of all the financial investments. Financial Planners suggest against NPS (National Pension Scheme) only because of EET status i.e. maturity proceeds are taxable. If you are in 30% tax slab then 9% tax free return is almost equivalent to approx 12% taxable return. It is always advisable to compare post tax returns for apple to apple comparison. Also, you should consider the fact that any taxation benefits availed can be reversed under specific conditions. For example, tax benefits availed u/s 80C on principal component of Home Loan is reversed if you sell the property within 5 years of purchase.

Another important aspect is capital gain. If you are planning to invest for more than 3 years then debt mutual funds are a better option compared to Fixed Deposits. The reason being Long term capital gain on debt mutual funds is NIL. On the other hand, the fixed deposit interest is taxable. Similarly, if you sell the property within 36 months of purchase the short term capital gain tax will eat into your returns. Therefore, it makes financial sense to sell the property after holding period of 36 months to take advantage of indexation.

5. Investment Horizon:

There is no standard definition of investment horizon i.e. short term or long term. By default, it is assumed that financial investments in Real Estate and Equity are long term. The reason being, Real Estate, and Equity cannot deliver instant returns due to cyclic nature of returns. The investment in these 2 options may prove to be risky in the short term if the entry and exit timing is wrong. As i shared in my posts on equity investments that last one year return of large-cap mutual funds is negative.

On the other hand, the nature of investments in Liquid Debt Funds, Fixed Deposits, Recurring Deposit etc is short term in nature. You will get returns approx equivalent to Govt Bond Yields. As an investor, i decide on investment horizon depending on the future requirement. The financial investments with long-term investment horizon can be invested in financial instruments with lock-in period like PPF. The reason being, investment is linked to the objective and probability to liquidate should be low or NIL.

6. Investment Objective:

The investment objective help in deciding other factors like Risk Appetite as discussed in point no 1. If my investment objective is approaching within a year then i will not risk the capital. I will prefer to invest in liquid or arbitrage mutual funds. Even if investment objective is 3 years away, i will invest in the short term or long term debt funds depending on the interest cycle. The financial investments for investment objectives like retirement, kids marriage or education i.e. 15 to 20 years away can be invested in Real Estate or Equity.

7. Age:

I have discussed this point in my previous posts also. The age of person again helps to decide risk appetite. At a young age, i can take more risk as my most of the investment objectives are long-term in nature. On the other hand, at the age of 50 or near retirement, my risk appetite is almost negligible. On the contrary, as i shared in the beginning that Age becomes irrelevant if my income is unstable or no of dependents are 4-5. Therefore, all the points shared in this post are somewhere interlinked to each other.

8. Source of Income:

Salary is a more stable source of income compared to being self-employed or a businessman. At the same time, if you are working in HIGH-Risk sectors like IT, Telecom etc where the job stability is not guaranteed then your financial investments should be low risk.

The families with double income are more secured compared to single income family. On the contrary, it also depends on your savings %. As a thumb rule, you should save min 30% of your income that is national savings rate. A double income family can save more i.e. up to 50%. The reason being, the monthly household expenses should be fixed in absolute terms rather relative in nature. In other words, double income should not mean increased expenses.

9. No of Dependents:

If the no of dependents are more then an individual should prefer least risky stable returns from financial investments. In the case of dependent parents, an individual has to provision for the monthly expenses of parents. Moreover, he has to take care of medical expenses of old age parents. It makes an individual more risk averse. All the basics of financial planning go for a toss in such scenarios. Therefore, as an investor, we should always consider the no of dependents before any decision on financial investments.

10. Financial Knowledge:

Any investment without sound financial knowledge of a particular financial product is suicidal in nature. Even debt mutual funds can deliver negative returns in the short term. The financial planners label them as the safest option but unfortunately it is not true. I have discussed this in detail in my posts under personal finance section.

You cannot depend 100% on financial planners, friends, relatives, colleagues etc for financial knowledge. The world economic scenario is volatile and fragile. The old school of thought may not be relevant today. My parents are of the opinion that GOLD is the safest bet among all financial investments. This myth was broken when gold collapsed from near Rs 34,500 per 10 gm in Aug 2013 to near Rs 27,000 per 10 gm in the first half of 2016. Therefore, it is imp to understand the factors that influence the movement of gold prices. Any blind investment in gold means putting your capital at HIGH RISK.

11. Past Performance:

It’s a human psychology to decide on financial investments based on past performance. To share my own example, in 2012 i bought gold at Rs 27,000 per 10 gm and made handsome gains by selling at Rs 33,000 per 10 gm. The reason for the increase in gold price was increasing inflation. The gold is the best hedge against inflation. This point always weighs in my mind as and when i think about financial investments. Though it is not a right approach.

While making investment decisions, we should think rationally rather influenced by past performance. I am not saying that past performance is not important but it should not be the sole criterion. As i always share in my posts on investments that macroeconomic indicators are very useful to gauge future returns. In the case of any confusion, it is better to wait and watch for more clarity. The safest bet is to open Fixed Deposit or invest in Liquid/Arbitrage Mutual fund and wait for right time to invest.

Summary: We should not be adventurous with our financial investments. In this post, i highlighted 11 imp points that i always keep in my mind for my investments. Though all these factors are interlinked in one way or another. It is imp to evaluate each one of them separately. Alternatively, we can make a score card. For example, on a scale of 1 to 5, if i have 5 dependents then i will score 1. Similarly, if i have a very stable source of income, i can score 5 under the source of income. The objective of this exercise is to zero in on the financial investments. Always remember that “it is very easy to lose a Rupee but very difficult to earn the same.”

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