Even though saving money in bank accounts is a good idea and provides an essential safety net, many cash savings accounts offer low-interest rates. Hence, they may not be ideal for saving for long-term goals. Your cash savings account may not keep pace with inflation. Thus, your money may lose buying power over time. Investing may help in such a situation.
The benefits of investing include the potential to make your money work harder for you and the possibility (but not the guarantee) of achieving higher returns. Investments do not require large amounts of money—you can begin with as little as INR 500—but you must invest for a minimum of five years.
To prepare you to make better decisions, let's examine investment meaning, the types of investments, and things you should consider before investing your hard-earned money.
What Is Investment?
Investments are items or assets acquired to generate income or appreciation. The fundamental logic used here is that assets appreciate over time and their value increases.
Investments can also be about investing time or money for the benefit of your own or others' lives. However, in finance, investment definition involves the purchase of securities, real estate, and other valuable assets to maximize returns.
A person who purchases a good as an investment does not intend to use it for consumption but rather to create wealth with it in the future. One can use the wealth created for a variety of purposes, such as meeting shortages in income, saving money for retirement, paying back loans, paying tuition fees, or buying other assets.
There are two ways in which investment can generate income for you. The first is that you may earn income from the sale of a saleable asset. Alternatively, you invest in an income-generating plan and earn an income through accumulating gains.
Investing always involves some level of risk. Your investment can be at risk of not generating a return or even losing all of your money altogether. Government securities, for example, carry a low risk. The risk is high when investing in stocks, starting a new business, or expanding an existing business.
How an Investment Works
Having learnt what is investment, let's discuss how it works.
The concept of investing is the acquisition of an asset today to reap benefits later. Investors invest money to generate income either from capital appreciation over time or from regular income from the investment. The act of investing includes the purchase of property, shares, bonds, and machinery. Additionally, investing in education improves knowledge and skills that will contribute to earning income in the future.
A risk is associated with investing for the future since investments could lose value. You could invest in a business that goes bankrupt or a project that does not come to fruition. A primary difference between saving and investing is that saving involves accumulating money and has no risks while investing involves leveraging money for potential future gains.
As investors, you need to assess our investment objectives and align them with several investments. Then, choose the one that meets our needs the best. After investing, you must monitor their portfolios continuously and, if necessary, realign them. Investor can always take the help of a financial advisor during a time crunch or when they do not possess enough knowledge to execute such transactions. The financial advisor assists investors in choosing the most suitable investments and monitors them continuously.
Types of Investments
Having discussed what is the meaning of investment, and how investments work, let’s look at their types.
Investors can invest in four main asset classes to increase their returns: stocks, bonds, commodities, and real estate. Additionally, some funds buy different combinations of basic securities, including mutual funds and exchange traded funds (ETFs). These funds are made up of hundreds or thousands of individual investments.
A company sells stock to raise funds for its operations. Stock ownership gives you a partial stake in a company and enables you to participate in its gains (and losses). Stocks can also pay dividends, which are periodic payments of profit made by the company.
Your goal when you buy stocks is to sell them for a profit once they rise in price. There is, of course, the risk that the stock's price will fall, resulting in a loss.
By investing in bonds, investors can “become the bank.” Companies and governments borrow money from investors by issuing bonds to raise capital.
By investing in bonds, you are lending money to the issuer for a specific duration. During the loan period, the lender receives interest payments. When you hold the bond for the contract's term, it matures and you receive your principal back.
Although bonds tend to have a lower return than stocks, they also pose a lower risk. However, bonds are not all risk-free. You may lose your bond if the company is unable to pay its debts or if the government defaults. Nevertheless, Bonds, notes, and bills issued by the government are considered very safe investments.
Investing in commodities involves purchasing physical products. Often, producers and commercial buyers use futures markets as a hedge against their financial risks.
Before investing in futures, retail investors should thoroughly understand them. Partly, this is due to the risk of sudden events causing the price of a commodity to move sharply in either direction. For example, political actions can greatly impact the value of oil, while the weather can influence agricultural products.
Commodities can be divided into four main categories:
● Metals: gold and silver (precious metals), and copper (industrial metals).
● Agricultural: Corn, wheat, and soybeans
● Livestock: Feeder cattle and pork bellies
● Energy: Petroleum products, crude oil, and natural gas
4. Real Estate
The best way to invest in real estate is to buy a home, a building, or land. An investment in real estate can be risky, depending on several factors, such as economic cycles, public school ratings, crime rates, and local government stability.
Consider investing in real estate investment trusts (REITs) if you wish to invest in real estate without owning or managing it directly. Real estate investment trusts generate income for their shareholders by investing in real estate. In comparison to stocks, they typically pay higher dividends.
5. Mutual Funds and ETFs
When you purchase shares of funds like ETFs and mutual funds, you can simultaneously invest in hundreds or thousands of assets. This easy diversification has resulted in ETFs and mutual funds having a lower risk profile.
The two types of funds, mutual funds, and ETFs differ in their operation. A mutual fund buys and sells a wide range of assets and is usually actively managed, which means an investment professional picks the investments. A mutual fund's goal is usually to outperform its benchmark index. The active and hands-on management of a mutual fund makes investment in the former far more expensive than an ETF.
ETFs also contain hundreds of individual securities. As opposed to trying to beat specific indexes, ETFs generally mimic the performance of existing benchmark indices. Investing passively means that your investment returns are unlikely to exceed average benchmark returns. Since ETFs aren't actively managed, they are usually less expensive than mutual funds.
Why Should You Invest?
Here are the reasons you should start investing:
- To safeguard your money
Investing is primarily about preserving capital. In some cases, investments can protect hard-earned money from eroding over time. Savings accounts, fixed deposits, and government bonds are reliable ways to protect your money. It is possible to preserve capital even if the return on investment is low.
- To grow your money
Investing money also aims to build a significant corpus over time. People secure their financial future by investing in capital appreciation over the long term. Real estate, commodities, mutual funds, and equity are some of the best investments for growth. There is a high risk associated with these options, but there is a high return as well.
- To earn a steady source of income
Investments can also provide a steady source of secondary income. Investing in fixed deposits that pay regular interest or stocks of companies that consistently pay dividends is an example of such an investment.
- To achieve your financial goals
The right investments can also help you achieve your short-term and long-term financial goals without too much effort or stress. Many investment options, for example, offer short lock-in periods and high liquidity. Investing in these instruments is a great way to save money for goals like home improvement projects or emergency fund creation.
- For tax deduction
Investors also have other compelling reasons for investing besides capital growth or preservation. Tax benefits are one of the reasons for this motivation. Tax deductions can be claimed for investments like Public Provident Funds (PPFs), and Equity-Linked Savings Schemes (ELSS). Doing so reduces your taxable income, which reduces your tax liability.
- To save up for retirement
Retirement funds are essential because you may not be able to work forever. You can grow your funds to support yourself after retirement with the right investment options.
- Be part of a new venture
Investors provides the money needed for new ventures. Investments in new, cutting-edge products or services or belonging to something like a business or film that introduces them to the glamorous side of life may appeal to some investors.
When Should You Invest?
Many people spend years pondering about investments and figuring out the benefits and objectives of investing. They don't consider investing a means of creating wealth because it involves risk. However, the risk associated with many investments is low to moderate, and some are risk-free.
The best time to start investing is when you are young. During this time, you have a better chance to experiment with different investments and leverage those that meet your needs.
Investing early in your career will also enable compounding to work its magic on your investments. Hence, the ideal time to start investing would be the day you start earning. Just make sure you invest in schemes that match your risk appetite, that is, your ability and willingness to take such risks.
Example of compounding
Here are two examples to help you understand. Imagine that you want to save Rs 4 crore for retirement. In the first scenario, you invest in equity mutual funds when you are 25 years old. For this, you would have to save Rs 6,000 every month until you turn 60. Your total investment would be Rs 25.2 lakh over the next 35 years.
Second, you delay the goal for 15 years and begin saving for retirement when you are 40 years old. As before, the target amount remains at Rs 4 crore. This delay will result in your monthly investments being 40,000, and your total investment amount is 96 lakh.
Therefore, delaying the investment by 15 years leads to a sixfold increase in your monthly investment and a fourfold increase in the total investment. Compounding works in this way over time.
Investors can now get started more easily than ever. Using an investment app on your smartphone or the web, you can open an investment account quickly. With a zero-commission account that supports fractional share investments, you can likely start with less than INR 500. Start investing now!