Lesson #7
Before you make any investment decision, knowingly or unknowingly, the following questions come to your mind:
- Will my money be safe?
- Will I get my money back when I need it?
- What return will I earn from it?
These questions are about the 3 essential elements of investments – Safety, Liquidity and Returns.
Let’s see what are you most likely to do if you were to focus on just one of the elements.
What is the safest investment? You would typically invest in a PPF, NSC, Government Securities/Bonds, Bank Fixed Deposits, etc.
What is the most liquid? Well, cash in the locker, money under the mattress or your savings/ current account are the likely places.
What will give the highest or best return? Now, that’s where the conflict begins. Will this also get you highest safety and liquidity?
As you probably realise, that is not the case.
While you would want the highest returns at the lowest risk with the ability to claim your money any time, the combination is hard to get.
Investing requires you to make trade offs.
When you invest in real estate, you trade off liquidity.
When you invest in stocks, you trade off safety and take on market risk.
When you invest in Fixed Deposit, you trade off returns.
3 Essential elements and Financial Investments
When it comes to financial investments, there are 3 broad choices: Cash, Bonds and Equities.
Cash is the safest, very liquid but the return is low or zero.
Bonds or Fixed Income or Debt will assume moderate risk, are less liquid (some even have lock-in periods) but will offer a better return than cash.
Equities will have higher risk yet liquidity is easily available through markets. The returns too are expected to be higher than bonds or cash, though not assured.
Within the 3 classes, there are further sub-classes that you can rely upon.
Liquid funds are as good as cash but deliver better returns than cash in the bank.
Government Bonds are safer and more liquid than Corporate Bonds, but would deliver lower returns than the latter.
A diversified mutual fund is a relatively less risky than owning just one or 2 stocks or a sectoral fund like Pharma, Banking and Energy.
So, where should your investments be?
Well, first understand your financial goals, assess the time available for your investments to work and what return do you need to meet your goals. Decide your investment mix based on these factors.
A good investment portfolio optimises the 3 essential elements to achieve financial goals and build wealth.
As a broad guideline, long term goals can benefit from a mix of bonds and equity, while immediate or short term goals are better taken care of by cash / liquid investments.
It’s not that you cannot achieve your financial goals by investing in Fixed Deposits or PPF. The only downside could be that you might have to work a lot harder than your investments.
Finally, if any of this makes you sweat, please talk to your investment adviser.
Here’s a quick quiz.
- What will you choose for your emergency funds?
- What mix of safety, liquidity and returns will suit your long term goals like retirement?
- In terms of safety, liquidity and returns, where does Gold stand?
- What will you do to beat inflation?
This note is a part of the free course – Investing 101. Want to receive other lessons of Investing 101 on email?
