Understanding Return in Investment Products and Risks affecting the
Return .
We all invest in various
investment products .Debt , Equity , Physical Gold and Real Estate are the main
assets for investment in India . Everyone wants good return but at the same
time does not want any loss . So it is very important to understand how return
comes and from where the risk i.e possible loss can come .
Return comes in two form –
Regular and Capital Gain . In case of Debt the regular part is Interest Income,
in case of Equity it is Dividend income . In case of Real Estate it is rental
income. Gold does not offer any regular return if invested in pure physical
form. Capital Gain booked when you sell the investment and the gain coming out
of difference between purchase price and redemption price forms Capital gain.
Lets take example of Debt .
Return == Interest + Capital
Gain.
The risk associated with interest
rate i.e may not get interest comes from the credit quality of the company
where one has invested . Generally if you invest in good investment grade paper
the risk of not getting interest does not exist. So within investment grade
also return component from interest gets enhanced by moving from AAA rated to
AA+ or to AA or to AA- . The second return comes from capital gain i.e when you
sell. This is affected by the duration of the debt securities and the impact of
change in interest rate scenario in the economy . If general interest rate goes
up you will get capital gain but in case general interest rate in economy goes
down there might be capital loss . If the term to maturity is less the impact
of capital gain or loss will be less and if the term to maturity is more the
impact of capital gain or loss will be more . So the risk to your return
component from capital gain side is mainly due to trend in general interest
rate movement .
The best way to look for return
and also manage risk is to get debt mutual fund product . In case of rising
interest rate scenario your investment should be into short term fund or
floating rate fund having investment grade securities . In rising interest rate
scenario Fixed Deposit and Fixed Maturity Plan are also an option . In falling
interest rate scenario be in long term
debt fund or in a duration fund where the fund manager is increasing or
decreasing the maturity of portfolio by shifting from short term debt
securities to long term debt securities and vice versa. One thing any investor
must bear in mind that due to higher tax rate investment in debt in any form
reduces the net return post tax . You get some indexation advantage if done in debt
mutual fund and the stay is long period (more than 3 years ) .
Lets take example of equity .
Return == Dividend + Capital Gain
Dividend is paid from accumulated
net profit . It also depend on the company policy i.e. whether they want to
plough back profit for business growth and expansion or want to share with
shareholders . So the risk of not getting dividend here comes if the accumulated
net profit is inadequate and/or the company policy on dividend distribution .
On Capital gain side risk of making abnormal gain or loss emanates from time
aspect , economic scenario and quality of asset ( market cap of security ) . In
short term all equity securities prices are affected more by piecemeal news and
views associated with that company . This news and views may be a fraction of
company’s total related information but it creates an impact even for few days.
If economic condition is good or stock market rising then even in short term
there are more gains than loss . Large cap stocks again rise slowly vis a vis
mid cap stocks if stock market is rising but they fall also slowly vis a vis mid
cap when stock market is falling . Analysis of piecemeal news and views is not
an easy job for a layman . How those things will impact the price and for how
long is definitely not a layman cup of tea. So when some one invest directly in
stock first mentally he should be prepared for this . Secondly he should have
some authentic professional guidance on stocks where he is investing . Your
gain or avoidance of loss depends on how quick you respond to price change and
also quality of holding . Short term direct equity investment adventure have
been loss making result for most . Some of the risk that can affect your return
is ( a) selection based on temptation or herd mentality ( b) If trying to time
the market end up being less proactive to get in or get out of a particular
investment at right time . In long term if the stock you have selected is good
one it will give you good capital gain as in long term net earnings of the
company gets properly correlated with the price of stock .. The best way to
mitigate the temptation risk , time risk, stock selection risk , lack of proper
understanding etc is best managed by investing through Equity mutual fund where
research based investment decision making is done and the portfolio is
constructed keeping diversification aspect so that over all portfolio risk is
minimised. Portfolio is managed both with stability aspects i.e investment in
good businesses and also encashing on
opportunities provided in short term due to price volatility .
Gold presently look to give
capital loss in short to medium term. Yes if someone is linking it with need
based ( for marriage , gift etc) after 10 years from now then he can look for investing
in Gold ETF through SIP ( Systematic Investment Plan ) . The proportion of Gold
should be 5-7 % of overall portfolio value in all economic scenario . Gold has
very less reproductive value and its price movement mainly depends on demand
supply factor . Supply side has limitation but demand will grow either for
investment reasons or sentimental reasons or family function compulsion reasons
.
Real Estate is good and has given
good returns but again has liquidity problem, requires large corpus for
investment . One risk is at many places the price has almost stagnated last few
years so one needs to evaluate the location risk . Real Estate investment is
good when one does not require money in short to mid term and also enough other
liquid investments ( Debt/Equity/ MF) to take care in case money is required. Else
the notional return i.e return on paper is inconsequential in real terms as it
is not going to help you when you require money for meeting some important need
.
So pl always remember Investment
is nothing but deferred consumption and fine balance on Liquidity , safety and
return to be made as per your overall need and requirement.
