What is Investment? Process, Factors Affecting Decision, Types

What is Investment?

Investment refers to the process of deploying money, finances or funds with the expectation of getting returns in due course of time. Investment is the use of money or capital to purchase financial instruments or other assets for gaining profitable returns in the form of interest, income, or appreciation of the value of the instrument.

Making an investment requires an individual or organisation to choose from among a whole gamut of investment options such as a pension fund, mutual funds, fixed income securities, etc. It requires some analysis or thought to invest money in a vehicle, instrument or asset, such as property, commodity, stock, bond, financial derivatives, etc.

This is because each of the financial instruments has some risks associated with it. Thus, investing requires analysis on the part of individuals and organisations to opt from among instruments that have certain level of risks associated with the possibility of generating returns over a period of time. When an asset is bought, there is anticipation that some return will be received from the investment in the future. Investment is related to saving or deferring consumption.

The main features of investment are:

• It utilises excess finances or funds.
  
  
• Its purpose is to derive benefits in the future and not in the present.
  
  
• Investments may also incur loss.
  
  
• It is assumed that the investor is well-versed with the available investment options and has worked out a plan to effectively utilise his/her finances.

Investment Process

Investment is a complex process as there are several points that the investor needs to consider while making an investment.

Some of these points are:

• The investor must take a decision on how much funds he/she should invest.
  
  
• The investor must decide on how much of the total funds to be invested should be allocated to various schemes. For this, he/she might also take the services of a portfolio manager or an investment advisor as any wrong step at this stage may result in losses.
  
  
• The investor must take into consideration the risk factor of the various schemes in which he/she will be investing the funds.
  
  
• The investor must take into account the tax liability that he/she will incur by way of investment in various schemes as all schemes have different tax liabilities.
  
  
• Besides these, there are other factors such as the market conditions, the rate of inflation, the employment scenario in the market, the ongoing political situations of the country, the stability of the government, etc., that also need to be considered before making any investment.

Figure shows the various steps involved in an investment process:

• Analyse Situation: This step involves evaluating the investor’s age, risk profile, time horizon, current financial situation, and expectations on return. This helps in providing an insight in how the individual’s money needs to be invested.
  
  
• Create Custom Plan: Based on the analysis, an investment plan is created. The funds are placed into proper investment vehicles based on the investor’s goals, time horizon, and risk appetite.
  
  
• Determine Allocation: The funds are allocated in such a manner that helps the individual in attaining his/her goals without overstepping the tolerance for financial risk.
  
  
• Implement Plan: The asset allocation is executed.
  
  
• Measure and Adjust: This step involves regular monitoring and making adjustments based on changes in an individual’s situation and the investment markets.

Factors Affecting Investment Decision

Several factors impact the investment decisions of a person. The major factors that impact the decision of an investor are:

Education about Investment

An investor must be educated or must have some knowledge about investment and how it can help him/her utilise the money and finances effectively. The investor must also have the habit of saving money, as a reckless and spendthrift person will not be able to invest wisely.

Risk Tolerance of the Investor

It is important to understand the amount of risk that an investor can bear as all investment schemes carry some form of risk with them.

Market Dynamics

The condition of market of the particular portfolio helps in deciding whether it will be profitable to invest or not. For example, the real estate market in India is at a low point for the past few years and is not able to generate the returns as expected by the investors.

Status of the Investor

Factors such as the number of dependents, the disposable income for investment, tax liability, etc. affect an investor’s decision. For example, a person with dependents such as parents, wife, and children would prefer to invest his money for purchasing insurance policies.

Time Horizon

How long the investor wants to keep his money invested also affects investment decision. The longer the time horizon, the greater are the returns that an individual can expect as the risk element reduces with time.

Types of Investors

Classifying the types of investors is a complicated process as there is no fixed criterion. One way of classifying investors is based on the manner in which they invest the money, while another is based on their risk appetites, etc.

Educated Investors

These types of investors are aware of the investment process and the various schemes that are available for investment. Educated investors are cautious of the financial choices they make.

Uneducated Investors

These types of investors are unaware of the basics of investment but decide to invest their money as advised by their friends and relatives. They take calculated risks and invest only a portion of their savings.

Short-Term Investors

These types of investors capitalise their money for a short duration as they have shorter time horizon and prefer quick returns. They invest their money in schemes or portfolios which promise large amount of return in a short duration. These investors have high risk profiles.

Long-Term Investors

These types of investors usually invest for longer durations. Typical long-term investors are property dealers who invest their money in real estate for a period of 5- 6 years in the hope that the price of the property will rise immensely. Also, fixed income securities, bonds that provide steady return over longer time periods are preferred instruments of long-term investors. These investors usually have low risk profiles.

Risk-Averse Investors

These types of investors are unwilling to take any risk. Risk-averse investors detest taking risk, and therefore, stay away from high-risk stocks or investments. They often lose out on higher rates of return. Such investors look for safer investments and prefer investing into index funds and government bonds, which generally have lower returns.