In the financial industry, there are two concepts that form the basis of most transactional activities. One is savings and the other is investments. There is a huge difference between the two concepts when it comes to execution.
Investment in terms of financial context, means any money that is spent today in the hope of financial benefits that may be reaped in a future time frame. Any investment is the act of buying or creating assets with an expectation that the same would yield interest earnings or dividend or capital appreciation or any other return that is profitable as compared to the money put in initially. Almost all investments are differentiated from other kinds of transactions based on the aim of the money spent. Money spent on making investments is primarily with the aim of obtaining some sort of return in a specific period of time.
A lot of times people confuse savings with investments. Savings and investment are different from each other in their approach of utilizing the money involved. While saving may be understood as a passive way of accumulating wealth, investment can be seen as a more aggressive way of securing returns. Mostly, under savings, customers avail a savings account and stash away cash in that account. This cash can be used as and when required by the account holder.
Investments made in the finance industry can be divided into two distinct types namely, Traditional and Alternative. Let us look into each of these types one by one and see what investment categories fall into which type.
Traditional Investments
Investing in well-known financial products falls into the category of traditional investments. These include bonds, shares, real estate etc. These are categories which are quite popular among investors as active investment strategies to make your money grow. Following are the investment products that fall under the category of traditional investment.
A Bond can be understood as an IOU which is issued by an issuer (borrower) and to a lender. Generally, bonds are instruments used by public and private sector enterprises to raise huge sums of money which any bank is incapable of lending. These bonds are then issued in the public market by the borrowing entity and are bought by lenders for specific amounts of money. Thousands of lenders then come together to lend the required amount and the borrowing organization is able to raise capital for its operational or growth purposes.
However, since money is being lent to the issuer of bonds, there is also an interest component involved that is paid back to the investor in turn for his/her money. This interest is paid at a predetermined rate and for a specific period of time. Bonds fall under the category of fixed income securities since the interest on these can be exactly calculated for the time for which the bond is held. Bonds fall under the debt category and are therefore, comparatively safer financial instruments to invest in. However, with all financial tools risk is inversely proportional to returns and as such the low-risk attribute of this tool makes it a low return instrument as well.
Stocks or equity are shares that are issued by companies and are bought by the general public. This offers an avenue to companies to raise funds. Stocks entitle a customer ownership of a company. Shares, stocks and equity all imply the same thing. Shares are one of the most popular investment avenues in the world. This is because the returns offered by stocks is generally higher than any other financial instrument. However, to balance out the high return associated with stocks, the risk associated with these products is also quite high.
Any business may issues different types of shares based on the financial urgency and need. In exchange for the money, shareholders are issued Stock certificates.
Stocks are mostly divided into two basic types, common stocks and preferred stocks.
Small savings is another popular savings tool in the Indian financial market. The name itself suggests that these tools are meant for saving money in small amounts. The idea behind this financial tool is to enable the habit of saving in people from almost all economic sections. Some of the most common small savings tools are Sukanya Samriddhi Scheme, EPF (Employees Provident Fund), NPS (National Pension Scheme, Kisan Vikas Patra, Personal Provident Fund (PPF) etc. Almost all small savings schemes are initiated and facilitated by the government so as to enhance the spread and penetration of savings schemes in the country. Let us look into some of the most prominent schemes out of these.
Employees Provident Fund
Employees Provident Fund is another small savings scheme that is primarily offered by your employer. This includes salaried individuals of both private and public organizations. Any company with a workforce of more than 20 employees is mandated to register for the EPF scheme. Around 12% each month is deducted from the salary and contributed towards the EPF account of an employee. This EPF account is maintained by the Employees Provident Fund Organization, commonly known as the EPFO. The amount deposited towards EPF is eligible for tax exemption under section 80C of the Income Tax Act.
Sukanya Samriddhi Yojana is a special scheme which has been launched by the central government to facilitate the financial wellbeing of girl child in the country. This scheme can be availed by parents or legal guardian of a girl child and an amount as low as Rs.1000 per annum can be deposited under the scheme. The account matures only after the girl child reaches the age of 21. Premature withdrawal is allowed only after the girl reaches the age of 18 years and has financial need pertaining to wedding or education.
National Pension Scheme
National pension Scheme is one of the most popular schemes for ensuring a regular pension amount to individuals working in both the private and the public sector. NPS is offered to individuals either as part of their corporate perks or is availed by individuals on their own. The amount set aside towards NPS is eligible for tax rebate under section 80C of the Income Tax Act. The scheme offers withdrawal of deposited amount only once the account holder reaches the age of 60 years. The corpus withdrawn on maturity is absolutely tax-free.
Mutual funds are financial instruments that are professionally managed and that invest money on behalf of any investor, in different securities. These mutual funds are classified into various types based on the type of securities that they invest in. Some of the most popular mutual fund types are balanced funds, stock funds, open-ended funds etc. These funds are classified based on their percentage allocation in different securities. So, an equity fund invests purely is equity and is a high risk high return product while a debt fund invests purely in debt and money market instruments and is hence a low risk low return financial product.
As the name itself indicates, fixed deposits are financial instruments that are one of the oldest and safest ways to save money. These are not necessarily active investment tools, but are rather a passive way to save and earn returns. A fixed amount of money is kept aside with a financial institution for a fixed number of days or months or years. In turn, interest is earned on this money. The rate of interest differs with the deposit tenure and also with the banking entity.
Similar to fixed deposit is the concept of recurring deposit. However, the only point of difference in the two investment tools is that while a lump-sum amount needs to be fixed in case of fixed deposit, a smaller amount needs to be deposited at regular intervals in case of a recurring deposit. Hence, customers who do not have a large chunk of money to fix in a single go can opt for a recurring deposit wherein money is usually deposited monthly for a specific deposit tenure. The rate of interest earned on recurring deposit is similar and comparable to that earned on fixed deposit.
Property rates are soaring with every passing day which has made real estate a hot investment avenue for investors. Buying, selling and leasing of property offers substantial returns to investors. Appreciation of property makes real estate a good investment tool. With urbanization gaining ground rapidly, real estate prices in certain major cities like Mumbai, Bangalore, New Delhi, are skyrocketing. This has made these places hot hubs for real estate investors. Most investors take loans from banks to purchase real estate and then lease out or sell the same property to enjoy returns offered due to appreciation in price of the property.
Alternative Investments
Alternative Investments are those that are not regular investments like stocks, bonds etc. These are investments made in order to acquire jewelry, precious metals etc. which are expected to yield returns in future. Hedge funds, some real estate types, venture capital and derivatives also form a part of alternative investment. Alternative investments are so called due to their non-traditional as well as complex nature. Also, another distinguishing feature of alternative investments is relatively low liquidity and well as very high minimum investment limits.
While a common investor may not access alternative investments like hedge funds or derivatives due to their complex nature, others like gold and real estate are available to even the common man. Let us look into some of the most prominent alternative investment tools known to investors.
These can be understood as a professionally managed private investment company or partnership structure. Techniques to manage the fund can be those that are not commonly allowed for SEC regulated companies. Hedge funds invest in both financial derivatives and/or publicly traded securities. These are popular as an alternative investment tool owing to their high leverage and high returns. However, they are characterized by high fees as well as low liquidity. It is seen that managers of hedge funds generally have a personal stake in the fund.
Private equity is trading in shares of an operating company that is not publicly listed and whose shares are not available on the stock market. Institutional investors employ various strategies to indulge in private equity trading. Private equity is popular since it offers diversification of financial portfolio by allowing investment in avenues that are not tightly coupled to normal investments.
Venture Capital is one of the most popular investment strategies currently being deployed by investors in the Indian start-up scene. The idea behind this investment strategy is to invest substantial capital in a budding company in return for stocks of the same. This is done with companies who are either in their initiation phase or in their growth phase. Venture capitalism is generally based on ideas that find substance with the investors or any new technology that the investors feel might take the market by storm in future.
This type alternative investment involves managers using futures also as part of their investment portfolio. Managed futures are a great tool to offer portfolio diversification and therefore are a great alternative to minimize risk and maximize returns. In general, a managed futures account will have sufficient exposure to different markets like energy, agriculture, commodities, currency etc.
Structured products are alternative investment tools that generally combine two or more financial instruments to make a packaged investment strategy in a single product. Most often, derivatives are combined with securities or with other derivatives. Structured products have a fixed maturity date like bonds. These offer a convenient strategy to implement a complex investment strategy across various financial products.
Collecting artifacts that have substantial value and those that have historical and artistic significance is one of the most difficult types of alternative investments. This requires knowledge of the article that you are purchasing. Mostly, collectibles like stamps, jewelry, boats, planes, art works etc. tend to appreciate in value and are considered good and profitable assets to own. The value of artifacts is generally expected to appreciate and keep pace with inflation and hence collectibles make a good form of alternative investment.
There are a few more alternative investment instruments available in the financial world. However, their use is limited since these are more complex products and are hence not considered by the common investor. Seasoned investors and professional investors tend to consider these alternative investment strategies to increase wealth.
Investment is one of the most important aspects of financial planning. The aim is to make sure that the money earned by you does not lie around being unproductive. It is a good and profitable idea to make money from any extra cash that a person might have. Investing in various financial products lends growth to any financial portfolio. One thing that is absolutely clear is that any amount of money is sure to appear less with each passing day. This is because the value of say Rs.1000 will not be the same 5 years down the line as it is today. Same holds true for the value of Rs.100 10 years ago as compared to its value today. Hence, it is important to understand that saving alone is not enough for future financial goals. Any investor or common man needs to ensure that his or her money grows as well. Investment can be defined as any activity that involves using money in a way which offers returns in future. Mentioned below are some of the most important reasons for investing money.
As discussed in the sections above, there are two forms of investments that exist. One is traditional investment while the other is alternative investment. Based on this particular categorization, following are some of the most popular financial tools that fall under each category of investment.
Traditional Investment
Alternative Investment
One of the most basic question for people is how to start investing and what financial product to invest in? The answer to both of these questions begins with the analysis of financial assets as the first step. You need to see the amount of money that you have in order to begin investing the same in investment tools. The second basic but important point is to understand the financial goal for which you are investing.
There could be a host of reasons why an individual wants to invest money. It could be for meeting his financial needs post retirement or to meet the education expenses of his/her children. In any case, identifying the aim on investment is one of the most crucial steps since this will give you a fair idea about the investment tool to go for. The aim of the investment will also chalk out other relevant details like the timeline of investment, the quantum of investment and the type of financial product to zero down on. There are low risk as well as high risk financial tools in the market but experts suggest that young people should opt for high-return high-risk products while older people or those nearing their retirement should go for something that is low on risk and offers low to moderate returns.
Once the above listed crucial questions are sorted, the next step is to actually begin investing. This could be done on your own or by taking help from a financial expert. In either case, there is high chance that with the passage of time, you too will start gaining knowledge about investment avenues and related products.
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