“Investment” is a broad term that draws easy parallels with life itself. Some attributes of success in life—investing time, patience, and hard work—will help you achieve your financial goals as well. And as in life, everything will add up in the process of wealth creation.
Let’s try to understand how investments help in wealth creation and the different types of investments.
Introduction to investment
Investment refers to committing money to assets or commodities that tend to increase in value over time. The appreciation in value can be received by the investor either in the form of regular income through profits (dividends) or capital gains.
The primary objective of investing is to create wealth over the long term to meet various financial objectives like retirement savings, expenses for children’s higher education, home purchase, etc. Besides, investments also seek to generate higher returns than risk-free savings instruments such as fixed deposits and government bonds.
How do investments work?
We have seen that investment helps create value by way of regular income and capital gains. However, it is important to understand how they are different and which one has a more significant impact on your investments. Let’s dig in.
Capital gains: When your primary objective in making an investment is to buy the asset at a low price and sell it at a higher price, the profit thus earned is referred to as capital gains. Most people are keen on generating capital gains from their investment due to the possibility of getting higher returns.
Regular income: It can be in the form of dividends or interest income from your investments. Instead of buying and selling, many long-term investors prefer to hold stocks and earn dividend income. Likewise, investments in G-Secs and corporate bonds also provide interest income to investors at regular intervals.
What’s more, it is possible to enjoy the best of both worlds. Investors often spread out their investments to gain both capital gains and regular income to maximize their returns from investments. For instance, re-investing the dividend income back into the market would help enhance returns through free cash flow over a period of time.
Types of investment
There are three broad types of investment categories:
- Ownership investments
- Lending investments
- Cash equivalents
Ownership investments: Any investment that entails owning an asset is called an ownership investment. For example, investments in real estate, stocks, and cryptocurrencies can be termed ownership investments, as you own the assets once you have purchased them or invested in them. In recent years, crypto investment has emerged as an attractive mode of ownership investment. Leading Indian crypto exchange CoinSwitch offers a user-friendly platform to invest in crypto assets of your choice. When it comes to stock market investments, you have a wide variety of options available, ranging from investing in the Indian market to investing in US stocks through platforms such as CoinSwitch.
Lending investments: Investments in government securities, corporate bonds, and fixed deposits are termed lending investments. They are called so because you lend money to governments and corporations for a fixed rate of return. Compared to ownership investments, lending investments are considered less risky, though the return potential is less over the long term.
Cash equivalents: Investments that can be easily converted to cash in a very short period of time or are highly liquid belong to this category. Money market funds and treasury bills are examples of cash equivalent instruments.
How should you invest?
Even if you know about various types of investments, choosing the right asset mix for investments can be tricky because every individual has a different risk appetite and investment goal.
However, it would be a safe bet to follow some rules of thumb for investments. To zero in on the right asset mix, you can follow the 100 minus age method, which mandates that your percentage exposure to a risky asset class should be 100 minus your age.
For example, if your age is 30, going by the 100 minus age theory, your asset mix should be 70% in the risky asset class and the remaining 30% in debt instruments, which are deemed relatively safer.
Being a relatively newer asset class, investors would be deliberating if they should dip their toes into the crypto sphere. Should you invest in crypto? Your exposure to crypto assets, considered an extremely volatile asset class, should not be more than 5-10% of your investment portfolio. That said, the decision should be based solely on your level of risk tolerance.
When should you invest?
There is no better time to invest than now. Yes, you read that right.
Given their inherent volatility, timing the stock market and crypto market is difficult. You may succeed a few times, but not always. Therefore, one of the best ways to invest in cryptos or stocks is through a systematic investment plan or SIP mode.
How does SIP work? You need to commit to invest a small amount of money in the assets of your choice every month. It will help you to average out your investment cost, reduce the impact of short-term volatility, and eliminate investment biases. Investing through SIPs is very suitable for goal-based savings and would help inculcate the habit of financial discipline.
Why should you make an investment?
The answer should be obvious: to build wealth over the long term. However, investing is also about putting your money to work to generate funds to meet your financial goals.
Investing in fundamentally strong assets would help you generate an alternate income stream that will help you attain financial independence earlier. Investing would also help reduce reliance on a single source of income, create a large retirement corpus, and minimize the chance of incurring debt.
Objectives of investments
Finally, wealth creation should not be your sole objective in making investments over the long term. The other two core objectives of investments are:
Beat inflation: Inflation is often referred to as the silent killer of money as it erodes the value of money. Investing in asset classes like equity stocks, cryptocurrencies, and real estate will help your investments beat inflation in the long term.
Tax saving: Proper investment planning will help you save a considerable amount of tax by investing in various tax-saving schemes offered under relevant sections of the Income Tax Act 1961. For example, investments made in PPF, NSC, and ELSS can be claimed for tax deduction under section 80C.
In investment, as in life, slow and steady is an approach that should hold you in good stead. One should be mindful that investment is a long-term journey that demands patience and financial discipline. Staying invested will also help you reap the benefit of compounding, which will boost your investment returns. Happy investing!
What is investing?
Investing refers to the act of allocating money or resources into assets, ventures, or financial instruments with the expectation of generating profit or achieving long-term growth. It involves taking calculated risks to increase wealth or achieve specific financial goals.
What is the simple definition of investment?
Investment is the act of putting money, resources, or capital into assets, ventures, or financial instruments with the expectation of earning a return or generating income over time.
What are the 3 main types of investments?
The three main types of investments are stocks (equity), bonds (fixed income), and cash equivalents—short-term, low-risk investments such as money market funds or certificates of deposit (CDs).
When should you start investing?
You should start investing as soon as possible to benefit from the power of compounding and long-term growth. The earlier you start, the more time your investments have to potentially grow and achieve your financial goals.
Why invest when you can save money with zero risk?
Investing offers the potential for higher returns than saving alone. While there is risk involved, it can help grow your wealth over time, beat inflation, and achieve long-term financial goals that saving alone may not accomplish.