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.
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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:
Steps in 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.
Importance of Investments
Investments are important due to increase in life expectancy of a person, planning for retirement income, high planning for additional income due to high rates of taxation and inflationary pressure in an economy, the expectation of continuous stable income in the form of regular dividends, interests and other receipts.
The following discussion provides an explanation of these issues.
Longer Life Expectancy
Investment decisions have become significant because statistics show that life expectancy has increased with good medical care. People usually retire between the ages of 60 and 65. The income shrinks at the time of retirement because the annual inflow of earnings from employment stops. If savingsare invested at the right age and time, wealth increases if the principal sumis invested adequately in different saving schemes.
The importance of investment decisions is enhanced by the fact that there is an increasing number of women working in the organizations. Men and women areresponsible for planning their own investments during their working life sothat after retirement they are able to have a stable income through balancedinvestments.
Taxation
Taxation introduces an element of compulsion in a person’s savings. Every country has different tax saving schemes for bringing down taxation levels of a person. Since investments provide regular and stable income and also give relief in taxation, they are considered to be very important and useful if investments are made by proper planning.
Interest Rates
Interest rates vary according to the choice of investment outlet. Investors prefer safe investments with a good return. A risk-less security will bringlow rates of return. Government securities are risk-free. However, marketrisk is high with high rates of return.
Before allocations of any amount, the different types of securities must be analyzed to calculate their benefitsand their disadvantages. The investor should make his portfolio with several kinds of investments. Stability of interest is as important as receiving a high rate of interest.
Income
Investment decisions are important due the general increase in employment opportunities and an understanding of investment channels for saving in India. New and well paying job opportunities are in sectors like software technology; business processing offices, call centres, exports, media, tourism, hospitality, manufacturing sector, banks, insurance and financial services. The employment opportunities gave rise to increasing incomes.
Higher income has increased a demand for investments and earnings above the regular income of people. Investment outlets can be selected to make investments for supporting the regular income. Awareness of financial assets and real assets has led to increase the ability and willingness of working people to save and invest their funds for return in their lean period hence, leading to the importance of investments.
Investment Outlets
The availability of a large number of investment outlets has madeinvestments useful and important. Apart from putting aside savings in savingsbanks where interest is low, investors have the choice of a variety ofinstruments.
The question to reason out is which is the most suitable channel? Which investment will give a balanced growth and stability of return? The investor in his choice of investment has the objective of aproper mix between high rate of return and stability
Classifications of Investments
There are different methods of the classification of the investment avenues. These are explained below:
Physical investments
Physical investments are tangible assetslike motorcars, aeroplanes, ships, buildings, plant and machinery, etc. Some of the physical assets like machinery, equipment, etc. are usefulfor further production whereas some like gold and silver ornaments, motorcars, etc. are not useful for further production.
Financial investments
Financial assets are those which are usedfor consumption or for production of goods and services or for further creation of assets. Examples are shares, NSS certificates, bonds, etc.
Marketable and Non-marketable investments
Someinvestments which are listed on the stock exchanges are easily marketable and can be converted into cash in a short time e.g shares, bonds andother instruments issued by government or companies. Non- marketableinvestments like bank deposits, provident funds, insurance schemes, etc. cannot be bought or sold in the open market in the stock exchanges andthus are difficult to be converted into cash immediately.
Transferable and Non-Transferable
Instruments like shares,bond can be transferred in the name of others or can be sold or exchanged for cash or kind, whereas some instruments like insurance certificates and NSCs, cannot be transferred.
Short term and Long term investments
Short term investments are capital investments for a period of not more than one year. For example, short term deposits, purchase of short-term savings certificates, etc. Long term investments can be understood as capital investments fora period of more than one year. In the practice of large investment companies, long-term investments are detailed as follows:
- up to 2 years,
- from 2 to 3 years
- from 3 to 5 years,
- over 5 years.
Regional nature of investments
On the basis of regional classification, investment can be categorized as:
- investment abroad: investing in investment objects located outside the state borders of a given country.
- domestic investments: investments of funds in the objects located in the territory of a given country.
- regional investments: investment of funds within a specific region of the country.
The securities can be classified on the basis of the following factors also:
- Issuing authority
- Denomination
- Ownership and participation rights
- Term to maturity
- Income payments
- Degree of liquidity
- Tax treatment
- Individual or Composite Security
- Derivative of another security, etc.
