Understanding Return in Investment Products and Risks affecting the Return

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.