Investment avenues for youth

Investment avenues for youth

A basic principle of investing is that the investment avenue must match the investor's risk profile. For example, a high risk investment avenue would suit a risk-taking investor. Also the investment should aid the investor in achieving his financial goals and objectives. For example, if the investor wishes to save money to buy a car in a stipulated period of time, then his investments should help him achieve that predetermined goal.

Young investors have an edge over others on account of their age. In other words, a young investor has more time on hand as compared to a middle-aged investor or one who is closing on retirement. This in turns affords young investors greater flexibility while making investment decisions.

In this article, we discuss various investment avenues available to young investors and the various facets of each avenue.

1. Equities

You must have heard your friends and relatives mention investing in the 'share bazaar' or 'stock markets'. Actually they are referring to equity investing. Simply put, equities represent a share in the capital of a company i.e. ownership in the company. Hence an investor who invests in a company is also referred to as a shareholder.

When a company is listed on the stock exchange, its shares can be freely bought and sold by investors at the prevailing market price. Over shorter time frames (say less than 3 years), equities can be volatile (read high risk) investments. Factors like market sentiment come into play and contribute towards distorting the price of shares. However, over longer time frames, the company's valuation (its true worth) determines the market price of shares. Hence it is important that investments in equities be made with a long-term perspective. Sadly, in most instances, you are likely to hear about people trying to make a quick buck by investing in equities. Rest assured, this is the wrong approach to equity investing.

A common problem associated with equity investing is the method of selection. Often, investors rely on 'tips' to decide which company to buy into. They are essentially relying on hearsay and in a way, gambling and hoping to get lucky. Equity investing in the true sense requires research and in-depth study. The investor must understand the prospects of the company, the factors that affect the same; he must have an understanding of the economy, interest rates, political and legal environment, and a host of other factors. Clearly equity investing is like a full-time job that is best left to experts.

Despite equities not offering assured returns or safety of capital, they have the potential to add value to the portfolio. Over longer time frames equities have historically delivered higher returns as compared to other avenues like fixed income instruments, gold and real estate. As a young investor, given that you have age on your side, equity is a must-have in your portfolio. However, instead of directly investing in equities, it is recommended that you invest in the same via the mutual funds route or even, very selectively, the unit linked insurance plan route (more on that later in the article).

2. Fixed income instruments

As the name suggests, fixed income instruments offer assured returns. Hence you, the investor are aware as to how much return your investment will generate and over what time frame. Fixed deposits, small savings schemes (Public Provident Fund - PPF and National Savings Certificate - NSC, among others) and bonds are examples of fixed income instruments.

A differentiating factor between equities and fixed income instruments is the safety of capital. In an equity investment, the capital invested (i.e. the money invested by you) is at risk. When equity markets crash, forget earning a return, you may even lose a part of the capital. Conversely, investments in fixed income instruments from credible institutions and companies offer safety of capital. For example, assume that you were to invest Rs 10,000 in a fixed deposit that offers 10% return for a 1-Yr period. On maturity (a year hence), you will receive Rs 1,000 as interest income and the original investment i.e. Rs 10,000.

However, the stability in fixed income instruments comes at a price. Since the returns are locked-in, you will not be able to gain from any subsequent hike in interest rates. Also inflation (a general rise in price levels) hits fixed income instruments the worst. The real return on investments (i.e. rate of return on investment less rate of inflation) that represents the actual earnings made by an investor, takes a hit when inflation rises.

Ideally, fixed income instruments are best suited for investors with a low to moderate risk appetite. If an investor affords higher priority to stability of income and capital protection, fixed income instruments are his calling. As a young investor, a smaller portion of your portfolio should be invested in fixed income instruments to impart a degree of stability to the portfolio.

3. Mutual funds

While investing in equities and fixed income instruments, you (i.e. the investor) directly invest in the aforementioned avenues. Mutual funds put a layer between you and the actual investment. Mutual funds collect monies from a large number of investors and this common pool is then invested in line with the fund's investment objective. Each fund has a predetermined investment objective that determines where and how the monies will be invested. Also the investments are made by an expert i.e. the fund manager. The fund manager with his expertise and experience is equipped to make more informed investment decisions vis-a-vis retail investors.

Of course, the opportunity to invest in a mutual fund and gain from the fund manager's expertise comes at a cost. Investors in mutual funds have to bear costs in the form of loads and expenses. Often mutual funds are wrongly equated with chit funds. The two are about as similar as chalk and cheese. Mutual funds are professionally managed and regulated by entities like SEBI (Securities and Exchange Board of India) and AMFI (Association of Mutual Funds in India).

Apart from letting experts handle the investments, the mutual funds route offers another advantage - a wide range of options to choose from. Equity funds (invest in equities), debt funds (invest in fixed income instruments), balanced funds (invest predominantly in equities and a smaller portion in debt), monthly income plans (invest predominantly in debt and a smaller portion in equities), sector funds (invest in equities from a single sector), index funds (invest in stocks from a benchmark index) and fixed maturity plans (mutual fund equivalent of fixed deposits) are just some of the offerings that investors can choose from.

Clearly, mutual funds have a lot to offer to you as an investor. And the same should be the preferred vehicle for making investments.

4. Unit linked insurance plans

At Personalfn, we always maintain that insurance products like endowment plans shouldn't be treated as investment avenues. An insurance product is supposed to 'insure' i.e. it should take care of your dependants (family members) in your absence. Sadly, often we find factors like tax-benefits or returns playing a part in determining, which insurance policy is selected. The 'insurance' aspect is neglected.

Having said that, unit linked insurance plans (ULIPs) is one offering from the insurance segment that combines investment with insurance. In fact, it would be fair to state that ULIPs are more inclined towards investments rather than insurance. ULIPs invest in both the equity and debt markets. Hence their performance is market-linked. A well-defined sum assured (i.e. the sum that your dependants will receive in the sad event of you meeting with an eventuality) takes care of the insurance aspect. ULIPs have been dealt with in greater detail in a separate article.

The importance of a sound investment advisor

Conventionally, the neighbourhood agent was the individual that most relied on for making investments. This gentleman armed with application forms and an agency from the local post office was like a one-stop shop for investments. However, the present investment scenario is a lot more complex and requires a different set of expertise on the investment advisor's part. Peddling forms and collecting/delivering cheques are of secondary importance. Now, an investment advisor's primary role is to offer unbiased and expert advice. More importantly, the advice has to be right for the investor in question i.e. the advice should be based on the latter's needs. In other words, a 'one-size-fits-all' approach won't work.

On your part, you should ensure that you are associated with the right investment advisor at all times. He could well be the individual who plugs the gap between you achieving or not achieving your financial goals and objectives.