Dear all,
I am back after a reasonably a long time. I hope you and your near and dear ones are safe from Covid19.
Before you read further, I request you to read all the previous chapters of this blog at: PPF (Practical Personal Finance) Series (ppfbypathikvariya.blogspot.com) before reading this blog. It is because, without reading those chapters, you won't get the best out of this post.
As the previous chapter (PPF DIARIES: CHAPTER 4: ASSET ALLOCATION (ppfbypathikvariya.blogspot.com) clearly defines what an asset is, let us pay some more attention to the idea of various asset classes. Because, the optimum returns are generated by keeping the right asset allocation, with reference to your risk profile. Some asset classes are traditionally available and some have emerged over time. Not all the asset classes are meant for every investor. But still, knowing about the various asset classes at your disposal is a good starting point. I have avoided going into the jargons as much as possible.
Here are some asset classes/products that you should be aware of, before investing in them.
1. Fixed Deposit / Term Deposit: The most loved instrument here is a bank Fixed Deposit (FD). It is (arguably) safe, simple to understand, and highly liquid. It is a very good instrument to park your emergency fund. One should invest in an FD, if that money would be required after a year. Other advantage is that now FDs can be booked and broken online. Plus, if you need funds, and do not want to break (prematurely withdraw) your FD, you have the choice of taking a loan on the same FD. The bank will charge up to 3% more than the interest on that loan, that your FD is fetching. For example, if the FD is fetching the interest of 5%, the bank may charge up to 8% on the loan that you take, based on that FD. Plus, you will not be able to break that FD while you are serving such a loan. But, such a loan allows you to protect your investment.
The disadvantages of FDs are plenty too. Number 1 is that only some amount of FD is insured today (5 Lakh - Fixed deposit: Bank deposit insurance hiked to Rs 5 lakh per depositor by Budget 2020 (economictimes.com) So, if you invest more than 5 lakh rupees in one bank's FD, then, in case of the default by the bank, only Rs. 5 lakh are insured.
Second problem is that the post tax returns of FD are generally not inflation beating. So, if one FD is giving you the returns of 5%, but if you fall in the tax bracket of 20%, the effective, post tax return (real rate of return) of that FD works out to be only around 4%. The inflation rate is generally around 6 to 8% in India. It means that your savings are "losing their value" if you invest in FD. Like 4% real rate of return means -2% loss of value. (your real rate of return - which is 4%Inflation- which is 6% = -2%).
2. PPF / Sukanya Samrudhi Yojna: PPF is a darling of the middle classes in India. And rightly so. It is because the money invested in PPF fall under the EEE category with reference to tax. So, when you invest money in it, no tax is there to be paid, when the interest in credited in it, no tax is to be paid, and when you withdraw, no tax is to be paid. The only thing is, that PPF has a long lock in period, which is also a plus point in a way. PPF is surely a better product than FD, but the liquidity of PPF, is a bit problematic, when compared with FDs. Plus, investment in PPF also gets tax benefit under 80C.
3. New Pension Scheme: The New Pension Scheme is an evolving product. It offers a long term financial planning / retirement planning. It works somewhat like Mutual Funds, but has a lock in period till the investor turns 60. This article is meant to only introduce the various asset classes, so I am not going to write in detail about NPS rules/functioning. Its long term lock in is a drawback and plus point too - depends how you view that feature. One drawback is the compulsory rule to buy the annuity. If there is enough public demand, I will write a dedicated article on NPS. But, one needs to evaluate this product carefully before investing in it as it is still in evolutionary phase. I still believe that PPF rates somewhat better than NPS. While mutual funds are better for taking an exposure to the equity markets.
4. Gold: Old is gold, but gold will never be old! Yes, gold has always attracted the Indian investors. While solely investing in gold is never a great idea, it does play an important role in one's investment even today. Gold is a great product if -
1. you want to hedge against the risks of investing in equities. It is because, when the equity marks do not do well, gold generally has done well.
(Moneycontrol.com)
The above figure shows the historical returns of SBI Gold Fund, which mirrors the returns of the underlying asset (gold). You can see here that, in long run, equity and nifty (share market) performs in the opposite direction.
2. you want inflation beating returns. While the returns from gold have beaten in the long run, they have not been extra ordinary. Plus, gold may witness long term of very poor returns, especially if the share markets / equity markets do well.
(Moneycontrol.com)
The above chart shows the historical returns of SBI Gold Fund, which mirrors the returns of the underlying asset (gold). Its 5 years annualized return is 8.04%, which should be able to beat the inflation marginally.
Of course, while buying the gold, one should not buy the jewelry. It is because the gold value is diluted when you invest in jewelry. So, buying jewelry is like buying an show piece and not buying gold for investment. One can buy Gold ETFs, Mutual Fund (FOF) or RBI gold bonds instead. PayTM and other platforms allow one to buy digital gold too. That is the most modern and hassle free way of buying the gold. Or one can buy the gold coins/biscuits. But then you will have to "store" them at some safe place!
4. Equity: Investment in equity is a must. You can choose to invest using a demat account (by directly buying the shares) or you can choose to invest through equity mutual funds. Though equity and gold returns in India in last 15 years have been around 11 to 12%, that analysis is too narrow and suffers the recency bias (read this conversation:
Gold vs Nifty returns over the last 15 years : IndiaInvestments (reddit.com))
So, keeping aside the above debate, let us see why one should invest in equity. Investing in equity means you are investing in businesses! It is like, because you cannot do a business, you give money to those, who do business and become a part of their profit (loss - of course!). In long run, the economy is bound to go up. So, investing in businesses will allow your money to grow along with the growth of economy. Of course, the long term trend shows that returns from the nifty (share market) are going down, still, the returns from the equity have generally been able to beat the inflation in the long run.
The future of equity investment belongs to quant investing, passive investing and stock pickers. If you choose a wrong company or a wrong equity mutual fund scheme, staying invested in it for 15 years shall also be counter productive.
Investing in equity is like playing a test match. It is strongly advised that faint hearted should take advice of a SEBI registered financial advisor before venturing into it. Plus, people, who are nearing retirement, should also be careful while taking exposure to equity.
The first problem of real estate is that it works differently in different cities. Investment of Rs. 50 lakh in real estate in Mumbai and a small town like Anand will fetch different returns. Within Mumbai, the return will differ from location to location. So, one needs to know where to invest, at what time, and at what time, should one "sell".
Plus, despite having maximum documentation, real estate is an asset class, where a lot of cheating is possible. It is something that a layman may find too difficult to deal with.
Real estate may also suffer from "liquidity risk." If you want urgent money, and the market is going through a recessionary period, it would be very difficult for you to sell it (liquidate it). Gold, equity shares, FDs are very liquid in that sense.
5. Bonds: Bonds/debentures are the products that allow you to "lend" money to the companies and earn "interest". In a way, for a layman, they may be comparable to an FD. But, no! These are highly riskier products and one needs to be aware of the risks associated with investing in bonds. The company, to which, you have lent money, may simply say, "I HAVE NO MONEY TO PAY BACK TO YOU!" and you may lose the entire amounts.
But the plus point is that, the bonds / debt mutual funds (the type of mutual funds that invest in bonds or the products like that) enjoy indexation benefit in tax treatment. (
Indexation: Meaning, Benefits, Calculation and More (cleartax.in)) So, if you stay invested for more than three years in such mutual funds or bonds, you may get some tax advantage. That way, bonds are superior to FDs. But please do not forget - bonds are far more complex products, meant for only the sophisticated investors, who understand the risks associated with them.
Even government bonds have risk. "
Government bonds have almost no risk of default. However their prices change according to interest rate changes in the economy (called duration risk). The longer dated the bond is, the more sensitive its price is to interest rate movements. A rise in interest rate lowers the price of the bond and vice versa." notes this (All you need to know about government bonds purchase (livemint.com)) article.
6. Bit Coins / Crypto Currency: Because such assets are not regulated by any agency, one should not invest in them, unless one is having extremely high risk tolerance. I would not recommend investing in such asset classes. But, still, if you have some extra money and you are ready to take that extra risk (in the expectation of short term vulgar returns), you can definitely try your hand on it! Never invest more than 5% of your investible amount in this type of proudct.
