Investment planning is one of the most important steps in investment process, both for new as well as seasoned investors. Before beginning the investment journey, one should clearly outline the objectives and goals one wants to achieve while investing. Most of the seasoned investors are already aware of the nuances, but few important concerns which new investors need to address are related to return expectation, risk appetite, liquidity, inflation and taxation. In this article, we will try to understand the implications of these variables on investment decision process.
Return Expectation and Risk Appetite
We invest in an asset because it has earning potential and
earning will come in the form of returns. Different
asset classes have different earning potential together with the risk attached
to it. Thumb rule is “High Return High Risk” /“Low Return Low Risk”. In simple
terms, what it means is, you need to invest in high risk assets if you want
high returns and vice versa. Now the question is how to identify a correct mix
of risk and return. Answer to this question lies in the historical risk and
return attached to a particular asset class. This data is freely available and
you just need to google it. It’s recommended to peg your figures around
historical data so as to avoid disappointment in future. Remember, whatever may
be your risk appetite; capital preservation is of paramount importance as this
capital will be generating future returns for you.
Liquidity and Transaction Fees
While planning investment and choosing asset class, liquidity
(how fast the asset can be exchanged with cash) aspect should be properly
considered together with the transaction cost. For example, even though real
estate/land is a high return asset class, it’s highly illiquid. It comes with a
baggage of high transaction cost and due diligence issues. Asset class with
high liquidity and low transaction costs is considered a better investment.
Equity/gold ETF investment scores above property investment from liquidity
perspective.
Inflation
This is the toughest enemy you would face while investment
planning and asset allocation. Persistently high inflation (around 7%) now a
days, has made savings deposit, fixed deposit and PPF investments highly
unattractive. Returns in these investments are around 4% to 8% which barely
covers inflation. At the end, you are gaining nothing out of these investments
as your purchasing power remains the same. It’s recommended to place a part of
your investment corpus in asset classes which act as hedge against inflation,
like equities and gold. Investment option for Moderate investors, as it will
mitigate risk of inflation up to a certain extent.
Tax Implication
No one can escape tax demon. If we know this reality, then it
sounds prudent to take it into consideration while planning for investments.
There are some asset classes which are tax exempt and for others, there are
ways to invest so as to minimize tax burden. As, for example, equity as an
asset class is not tax exempt, but if you invest for long term i.e. more than
one year, your capital gains are tax exempt.
Conclusion
Investment planning points mentioned above should be properly
addressed, as ignoring any of them will eat away your returns in future.
Remember the famous saying “Prevention is better than cure”, it applies to
investment planning too.
