Financial planning is essential to our lives and helps us make informed investment decisions. It ensures our future financial security and provides funds for children’s education, marriage, and meeting milestones like purchasing a house and car. Moreover, you invest for your retirement to lead a financially independent life while leaving a legacy for your descendants.Read more
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A wise investment involves various instruments to get desired future returns through income or appreciation. However, first, let us learn what investment means.
Investment is putting money, time, and effort into something that will pay dividends in the future through profit or advantages. In a nutshell, today’s act fetches something better at a later date. Therefore, you can define investment in finance as purchasing an asset today and hoping for an income or value appreciation in the future.
Every individual divides their income into broadly two parts.
Buying goods, services, and assets for current consumption or appreciated value in the future.
Saving funds carved out from the income for planned and unplanned future expenditures.
However, savings often lie in bank accounts, cash at home, and locked-in assets. Nonetheless, investments are critical to ensure a better future. Summing up, you can say you are buying a day when to don’t need to work.
You can broadly classify investments into two categories depending on how they deliver future income. Both have a role to play in an enhanced lifestyle.
Fixed Income Investments: You park your money in investment vehicles like fixed deposits, bonds, and debentures to earn a percentage as fixed interest income.
Variable Income Investments: The return is variable for allocating your funds to equities or real estate. Dividends and rental income vary in a financial year, but their value appreciates long term.
Let us consider the factors for investment, keeping the above classification in mind.
Investments fulfill short and long-term financial goals
Investments mean to create future capital
Investments can target future returns
Investments made by individuals comprise bonds, deposits, equities, goods, and assets
On the other hand, business investments comprise plants, machinery, labor, R&D, real estate, and construction
Investment in education spurs knowledge and skills for the future
There are four common types of investments besides a few others. Stocks, bonds, commodities, and real estate are the most popular. In addition, mutual funds and Exchange Traded Funds (ETFs) are pooled funds invested in a portfolio of diverse assets. In other words, these investments are a collection of many assets.
Stocks: Companies sell shares to fund their business operations. You gain a slice of ownership when you buy these shares. In addition, some equities earn you a part of the profits through periodic dividends. However, the investment is fraught with risk due to market volatility. If the company is successful, your capital appreciates. On the other hand, you lose money due to capital depreciation if the company is unsuccessful.
Bonds: The government and companies sell bonds to raise money. While the former sell bonds to fund various projects, the latter raise funds to run or expand their business. Therefore, they are debt instruments borrowing money from you for a fixed tenure. As a result, you earn a fixed interest income while your loaned principal remains safe. However, not all companies selling bonds enjoy good credit ratings. Nonetheless, bond investments are less risky than stocks, but the returns are conservative.
Commodities: Commodities include agricultural products, oil, gas, energy, and metals. In addition, precious metals like gold and silver are the other commodities. These are raw materials for industrial use, and their value fluctuates due to the market movement. For example, an oil shortage boosts its price, and accordingly, your investment appreciates. Since commodities are high-risk items, it suits experienced investors.
Real Estate: Buying a house or a landed property is an investment in real estate that has the potential to rise in value over time. However, there is a risk due to external factors affecting the property’s value appreciation or depreciation. Alternatively, you can also buy Real Estate Investment Trust (REIT) shares instead of property to generate income. Consequently, the dividends are higher than many other investments.
Mutual Funds and ETFs: Many investors contribute to a pooled corpus for investments with a common strategy and create a portfolio comprising market instruments. As a result, Mutual Funds and ETFs hold diverse asset classes depending on the scheme objectives. Professional fund managers devise investment strategies to maximize returns and share the profits with the investors. Moreover, they have a track record of delivering higher returns than conventional investment vehicles.
Investments do not confine to the discussed common types alone. On the contrary, the alternative types are gaining currency despite higher risks and a lot of money to invest upfront.
Private Equity: Often, companies raise cash without going public. Therefore, private equity allows investors to pour money into private companies or buy them out.
Derivatives: These financial instruments derive their value from a different financial product, hence the name, such as a market index. However, they are high-risk and reward investment instruments.
Options: This derivative version gives you the right to trade securities within a specific timeframe.
Hedge Funds: Require substantial investments as the minimum or high net worth. Investors pool money to make high-risk allocations with hopes of earning a hefty profit.
Cryptocurrency: Digital currencies that do not have the backing of tangible assets, like Bitcoin. Cryptocurrencies trade without brokers with a track on digital ledgers. However, volatility causes vast value swings.
Investments in conventional instruments like the bank and institutional deposits bear a guarantee. In contrast, market investments always carry the risk of losing your money.
Investments are different from savings as you put your money into something with the potential to grow over time and deliver more value. In contrast, saving funds is about setting your money aside to meet current and short-term financial needs. Therefore, investments require a long-term commitment to return a sizeable profit in the future.
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