ANATOMY OF INVESTMENTS
Understanding its importance
Chapter I: Eco(nomic) system of a household:
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Household members from economic point of view are of two types – Dependent & Independent. The dependent members contribute to expenditure of household and independent members contribute to the income and also contribute to the expenditure. The young dependent members after growing up can become an independent member. Independent member in future may become dependent member because of retirement from work due to age, sickness or change in mindset.
Earning of a household is collective incomes of independent members of household. Incomes can be out of profession or business, investments or other sources like gifts received or winning of a lottery. If expenditure is less than earning there is a saving or else there is a deficit. The deficit could be met either out of previous savings or borrowings.
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Generally,
Earnings life cycle of an individual usually sees an increase, peak, sustainment, decline. In contrast expenditure sees a sustained increase because of aspiration of better standard of living and increase in costs of living (inflation). Expenditure is incurred from birth until death while income generation is restricted to working period of individual. Earnings level can widely fluctuate more for individuals in business than in profession.
Life span of individual is seeing rise. It also means increased period of dependency without business or professional income. It also means increased lifetime expenditure. Hence increased saving requirements is becoming compulsory for maintaining a good livelihood.
Chapter II: Savings & go to go about it
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Increased savings requirement for retirement life can be met by reduction of impulsive & unimportant expenditure, and also by deploying savings in investments which can generate higher returns. It requires a monthly savings of Rs7054 for 30 years at 8% to attain a corpus of Rs 1 crore. The same amount at 10% could yield Rs 1.5 crores (50% extra) or at 12% could yield Rs 2.1 crores (>100% extra) or at 15% could yield Rs 4 crores (4 times more). The analogy showcases that a mere 2% increased return in savings over a long period of time could yield 50% more money for the rainy times.
Savings can be deployed in many avenues like real estate, bullion, fixed deposits, debentures, equities, and many more. Channelizing of savings many times depend on an individual’s understanding of the subject. Lack of knowledge and exposure to various investment options is the key reasons for non-optimal investment choices.
Savings can also be deployed towards speculation activities. Many aspects like returns expectations, risk taking capacities, investment horizons, liquidity needs (to meet emergencies), tax implications, costs of holding, safety aspects & requirements of monitoring, succession issues tend to form guidelines for investment of savings of an individual.
Chapter III: Equity markets for channelizing savings effectively
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Savings can be put in equity markets for speculation and investment activities. The risks associated with speculation are very high. Investment activity can be done directly through a stock broker or indirectly by buying units of mutual funds or entering into a PMS contract with a portfolio manager. PMS offers customized management of investments and suited for investments beyond INR 25 lakhs. An investment in mutual funds is ideal for smaller investors. Direct investing isn’t the best approach as investment decisions call for detailed analysis of information from various quarters.
Investments in equities over a long term horizon has potential to yield much higher returns Vis a Vis other investment avenues. It offers tremendous liquidity with almost no price impacts. The holdings are held in electronic form with nomination facilities which makes it safe and hassle free. The transaction costs are minimal and dealings are transparent. While there are no default risks, the risks of depletion of principal can be minimized by systematic allocation of holding amongst different entities and sectors. The stock market indices have delivered about 20% post tax compounded returns during two decade period.
Risks of falling share prices can be minimized largely and effectively following proper diversification approach across sectors and avoiding entry at very high valuations. Discovering budding companies with good management and profitable business with ample growth opportunity and staying invested in them in their growth phase is key to big success in capital markets.
Continuous monitoring is important in equity investments because markets are very dynamic and react quickly to any news or development. A cautious approach reduces risks significantly. Technical charts and tooling also provides a good perspective in timing the market.
Disclaimer: This document is for investor awareness. Prudence needs to be applied prior to making investment calls. It needs to be reminded that investment in stock markets is subject to market risks.