It’s waiting that helps you as an investor. and a lot of people just can’t stand to wait. If you didn’t get the deferred-gratification gene, you’ve got to work very hard to overcome that – Charlie Munger
Investment can take place in many forms. Like one can make a monetary investment, like buying some real estate or one can invest in oneself, like by acquiring a new skill. Here we will talk about monetary investments which will help you to create long term wealth. So, let’s begin.
What is an Investment?
An investment is the buying of some monetary asset with the objective to generate income or to sell at a higher price in future or both.
Let us understand investment by an example. Suppose you purchased a house (an investment) and let it out on rent. Now this will generate rental income & in future, if the prices are high, you may even sell that house. Now the question arises, why should we do investment?
Why should we do investment?
You may ask why we should bother ourselves with the task of doing investments. There could be multiple reasons for making investments. But let us first talk about the most basic and critical one: to provide for us during our retirement days. One day you will become old and no longer be able to continue your employment. Means no monthly salary. For those days, you should have enough money to live a peaceful retired life.
Let us understand how investment can provide for us when we are retired.
Assume that you have an annual salary of 5 lac & you spend 60% of it & save 40%. Your employer is kind enough to give you an annual increment of 10 % in your salary every year & your cost of living increases @ 8%. You have 20 years before your retirement.
Case 1: You do not put your savings in investment. That savings is just sitting idle, not generating any income. In that case, this is how your total savings will look like after the end of 20 years.
|Year||Salary||Yearly Cost of living exp||Savings|
|Money available after retirement||17197009|
After retirement, you have a total of Rs.1,71,97,009. Assume that your cost of living continues to increase @ 8%. So, you will be out of money by the end of 10 years from retirement.
Now, suppose you decide to invest your savings @ 12% pa. In that case, the table will look like this:
|Year||Salary||Yearly Cost of living exp||Savings||Savings invested @ 12%|
|Money available after retirement||41811479|
Assuming your cost of living continues to increase by 8%, this money will last for around 18 years, a lot better situation when you do not invest your money.
Apart from this, other important reasons to invest:
To beat inflation. As your money grows older, it loses its purchasing power because of inflation. Rs.100 will be worth much less in the future than they are today.
To create long term wealth: Warren Buffet, the legendary investor, has ballooned his net worth to $80 Billion just by making sound investments.
To meet short term & long-term financial goals like buying a house, college education of children etc.
To save taxes. Deductions from total income are available on making investment in certain investible instruments like Equity linked Saving Schemes, certain kinds of fixed deposits etc.
Once we have reasons as to why to invest, the obvious question arises, where to invest and how much return one could expect. One must make a choice amongst the various investible asset classes. An Asset class is a category of investment with particular risk and return characteristics. Following are some of the popular asset classes:
Fixed Income Instrument: This asset class consists of financial instruments, where there is limited risk of losing principle while rewarding the holder with a fixed amount of interest. These instruments are issued for a fixed period, decided beforehand & after the expiry of such period, the principle amount is returned to the investors.
Typical Fixed Income Instruments include:
- Fixed deposits offered by the bank
- Bonds issued by the government of India
- Bonds issued by government agencies
- Bonds issued by the corporates
Equity: Investment in equities involves buying shares of publicly listed companies. Here, unlike fixed income instruments, there is no capital guarantee. However, as a trade-off, an investor in equity is rewarded with a higher rate of return. Indian equities have generated returns close to 14%-15% CGAR (compounded annual growth rate) over the past 15 years.
Investing in some of the best and well-run Indian companies has yielded over 20% CAGR in the long-term. Identifying such investment opportunities requires skill, hard work, and patience.
Taxation on Equity investments held for more than 365 days is taxed at 10%, if the gains are more than Rs 1 lakh starting from 1st April 2018(previously such investments were tax-free). This is comparatively a lower rate of tax than the other asset classes
Real estate: Real estate is buying and selling of land (commercial & noncommercial) & buildings (houses, apartments, offices). Income could be generated in two forms: Rental Income & Capital appreciation of the investment amount.
However, it requires huge investment. Everybody does not have such financial resources. Also, these are complex transactions involving legal verification of documents. There is no official metric to measure generated by this asset class, therefore, hard to comment.
Commodity – Bullion: Investments in gold and silver are considered one of the most popular investment avenues. Gold and silver over a long-term period have appreciated in value. Investments in these metals have yielded a CAGR return of approximately 8% over the last 20 years. There are several ways to invest in gold and silver. One can choose to invest in the form of jewelry or Exchange Traded Funds (ETF).
Now having considered the various options available, now let us see how much you would have received under different investment classes:
- By investing in fixed income instruments @ 9%, you would have Rs. 32568118
- If invested in equities with annual return of 14% per year, the amount at the end of 20 years would be Rs. 49855988
- Investment in Bullion at 8% would have left you with Rs. 30085065 at the end of 20 years.
Clearly, equities tend to give you the best returns especially when you have a multi-year investment perspective.
Important things to know before investing
- Return and risk are positively correlated to each other. Always remember the old adage, higher the risk, higher the return and vice-versa.
- It is important to consider rate of inflation as well. If your investment returns are 8% and inflation rate is 9%, then you are losing 1% every year.
- Returns in equity can be extremely attractive, making investment in equity a great option. However, these are risky investments. Not suitable for risk averse investors.
- Investment in real estate requires huge cash investment. Unlike other investible assets, it cannot be done in smaller amounts. Liquidity is another issue. You cannot buy or sell whenever you want to. You have to find the other party to the transaction, which may not be available at the required times.
- Gold and silver are known to be a relatively safer but the historical return on such investment has not been very encouraging.