What is the most ideal investment instrument?

A question that lingers not only in the minds of the new age working youth who intend to grow their earned money by investing in the right instrument but also experienced investors who are looking at various investment options to diversify their portfolio. How do we then find an answer to this simple yet multi-faceted question?

The answer lies in analysing and understanding the purpose of your investment. Today, multiple market instruments offer various benefits and returns, which can easily result in confusion. A wrong decision might cost you years of time and a loss of interest income. Hence, it is always advisable to enlist your investment goals and consult an expert before making a decision.

Once you decide your purpose of investment, it then becomes empirical to understand the available options in an in-depth manner. This is where we are going to help you.

10 most popular investment options in India

• Stocks

Stocks are securities that represent an ownership share in a company. For companies, issuing stock is a way to raise money to grow and invest in their business. For investors, stocks are a way to grow their money and outpace inflation over time.

• Mutual Funds

A Mutual Fund is formed when capital collected by various investors is invested in purchasing company shares, stocks, or bonds. Mutual fund investments are collectively managed by a professional fund manager to earn the highest possible returns.

• Real Estate

Real estate investment refers to any residential structure owned solely for generating investment returns, either through rental income or through market value appreciation.

• Public Provident Fund (PPF)

The Public Provident Fund is the long-term saving scheme introduced by the Ministry of Finance (MoF) in 1968. PPF is backed by the government of India and offers regular interest along with income-tax benefits.

• Fixed Deposit

Fixed deposit is an investment instrument where you can deposit a lump sum of money for a specific period, which cannot be withdrawn before maturity. It generally earns a higher rate of interest than a savings account.

• Equity Linked Saving Scheme (ELSS)

An equity-linked savings scheme (ELSS) is a tax saving mutual fund. A fund works by investing primarily in equities. The only difference is that these funds are subject to a lock-in period of 3 years and offer tax exemption under Section 80C of the Income Tax Act.

• Initial Public Offer (IPO)

An IPO is the first time the owners of the company give up part of their ownership to stockholders. What makes it different from buying a share from the market at a later stage is that IPO shares can skyrocket in value when they are first made available on the stock market.

• Bonds

A bond is a fixed income instrument that represents a loan made by an investor to a borrower. Investors lend a company or government money when they buy its bonds. In exchange, the company or government pays interest at predetermined intervals and returns the principal on the maturity date, ending the loan.

• Unit Liked Investment Plan (ULIP)

ULIP is a combination of insurance and investment. Here policyholder can pay a premium monthly or annually. A small amount of the premium goes to secure life insurance and the rest of the money is invested like a mutual fund.

• Post Office Savings

The post office savings account is a deposit scheme provided by the post office throughout India. The account provides a fixed interest rate on the account balance.

While we now know about the various financial instruments on offer, the next best thing to do would be to analyse and understand your purpose of investment.

What is an investment?

Investopedia defines an investment as an asset or item acquired with the goal of generating income or appreciation. In an economic sense, an investment is the purchase of goods that are not consumed today but are used in the future to create wealth. In finance, an investment is a monetary asset purchased with the idea that the asset will provide income in the future or will later be sold at a higher price for a profit.

What is an investment objective?

An investment objective is the most fundamental reason you are investing in.

An investment objective is determined by studying the investor's aversion to risk (risk tolerance) and how long the money is to be invested for (time horizon). Once the objective is determined, it will then dictate what particular asset classes and security types are needed to fulfill the purpose of the portfolio.

Your investment objective can have goals that range from gaining growth, income generation, to money preservation if you are retired or a combination or variation of those types. For example, some investors want to grow their account value over time but they also want to make some income from their investments. Therefore, this investment objective can be considered growth and income generation. Preservation objectives will usually seek to keep account values stable or, at a minimum, grow at a rate equal to the expected rate of inflation.

Growth Approach

There are many ways to grow a portfolio, and the best approach for a given investor will depend upon various factors such as their risk tolerance, time horizon, and the amount of principal that can be invested.

Growth can be defined in several ways when it comes to investing. In the most general sense, any increase in account value can be considered growth, such as when a certificate of deposit pays interest on its principal. But growth is usually defined more specifically in the investment arena as capital appreciation, where the price or value of the investment increases over time. Growth can take place over both the short and long term, but substantial growth in the short term generally carries a much higher degree of risk.

Income Generation Approach

Real Estate

Despite some difficulties in recent years, real estate continues to be a preferred choice for investors who want to generate long-term returns. Investing in a rental property, for example, is one way to produce a regular source of income. At the outset, an investor may be required to put up a 20% down payment to buy the property, but that may not be a barrier for someone who is already saving regularly.

Real estate investment trusts (REITs) are another passive investment option for investors who are not interested in dealing with the day-to-day burden of managing a property. One of the main advantages of a REIT is that they payout 90% of their taxable income as dividends to investors. There is a downside, however, since dividends are taxed as ordinary income. That may be problematic for an investor who is in higher a tax bracket.

Dividend Stocks

Dividend stocks are one of the easiest ways for investors to create a passive income because you're effectively being paid to own them. As the company brings in earnings, part of them is paid back to investors as a dividend. This money can be reinvested to purchase additional shares or can be taken home as a cash payment.

Dividend yields can vary greatly from one company to the next, and they can fluctuate from year to year. Investors who are unsure about which dividend-paying stocks to choose should stick to ones that fit the dividend aristocrat label, which means the company has offered increasingly higher dividends consecutively over the previous 25 years.

Index Funds

Index funds are mutual funds that are tied to a particular market index. These funds are designed to mirror the performance of the underlying index they track, and they offer some advantages over other investments for investors whose goal is passive income.

Index funds are passively managed, and the securities included in them do not change unless the composition of the index changes. For investors, this translates to lower management costs. Aside from that, a lower turnover rate makes index funds more tax-efficient, reducing drag that would otherwise detract from returns.

Money Preservation Approach

Preservation of capital is a conservative investment strategy where the primary goal is to preserve capital and prevent loss in a portfolio. This strategy would necessitate investment in the safest short-term instruments, such as Treasury bills and certificates of deposit.

Securities that are used for the preservation of capital have little to no risk and, in effect, smaller returns compared to the current income and growth strategies mentioned above. Preservation of capital is a priority for retirees and those approaching retirement, since they may be relying on their investments to generate income to cover their living expenses. These types of investors have limited time to recoup losses if markets experience a downdraft and give up any potential for high earnings in return for the security of existing capital. A major drawback of the capital preservation strategy is the insidious effect of inflation on the rate of return from "safe" investments over a prolonged period. While inflation may not have a significant impact on returns in the short term, over time, it can substantially erode the real value of an investment.

Characteristic nature of a real estate investment

The land is a scarce resource making the demand for this asset, undying. Owning a home is everyone's dream, and given the shortage of land in cities across the country, purchasing even a small flat can offer you returns, either in the form of rental income or by selling it for a profit.

Past trends reveal that between 2013 to 2018, residential property price appreciation in India stood at a mere 12% – effectively a little over 2% on a yearly basis, even for properties in prime locations. Hence, if one bought and sold such property within this period, their returns would have been less than satisfactory.

As per market data, yields in the affordable homes segment are higher as compared to the mid-level or luxury segment. There is also a significant variation between yields based on their capital values (Rs/sq.ft.) It has been observed that across cities where properties are priced below ₹6,000/sq.ft. the average rental yield is more than 3%.

On the other hand, properties priced at ₹6,000 per sq.ft. or more had rental yields between 2.4% and 3%. Hence, from a rental income perspective, it makes more sense to invest in affordable properties.

Backed by government concessions, affordable housing can feasibly give returns to the tune of 8-10% in the long term. There are also a number of alternate residential real estate investment options - including serviced apartments, senior living, smart city-based housing, and co-living. The monthly rental ROI for these residential sub-categories is a lot higher than for mainstay mid-income or luxury housing. For instance, co-living units can offer as much as 8-11% of ROI - a much higher yield than the current average yield of 1-3% in garden-variety residential properties.

Real estate as compared to others

Real estate is something that you can physically touch, feel and use - which is a lucrative element for many investors. Positive benefits to investing in real estate include tax deductions and elimination of capital gain taxes when you sell off the property as long as you invest the money into a similar property type.

It is more difficult to be defrauded in real estate compared to stocks if you do your homework because you can physically show up, inspect your property, run a background check on the tenants, make sure that the building is actually there before you buy it, and do repairs yourself. With stocks, you have to trust the management and the auditors.

Like all investments, real estate also has its drawbacks. Most importantly, investment is not liquid. When you invest in a property, you usually cannot sell it right away. In many cases, you may have to hold the property for several years to realize its true profit potential. In addition, the closing cost can add up to thousands of rupees, and include taxes, commissions, and fees.

Further, real estate prices tend to fluctuate. While long-term prices generally increase, there are times when prices could go down or stay flat. If you have borrowed too much against the property, you may have trouble making the payment with a property that is of a lesser worth of money than the amount borrowed on it.

There is an additional way that you can be able to diversify in real estate through real estate investment trusts (REITs), under which you can purchase a trust that is invested in a large portfolio of real estate and will offer you a dividend as a shareholder.