December 31, 2005

Equity or Debt Instruments

Before we decide which instrument to invest in, lets understand the various instruments on hand. The well known Fixed Deposit is what comes to all our minds. So, is 'the product' to invest in. Sadly, if one were to ask me, I would rate this to be the worst product. Before I explain, lets see the other products.

What is it that I look at when choosing a product.

  • Safety: This is something that comes to my mind instantly when I invest. While safety can be interpreted differently, to me it refers to the cushion the product gives for the risk that I am willing to take.
  • Risk: This is probably the worst word to define. Risk is interpreted differently by everyone and everyone. To me it means that there is a probability of loss and I expect a compensation for it. Now different product come with different levels of risk. There are different types of risk. One when the product has a risk and one when external factors act on it to change the price of the product. For example, when BJP lost the election, the stock prices crashed across the board. This is an external risk. When prices of Infosys crashed when it came out with a disappointing earnings guidlines in 2003, it was an internal factor. Apart from this you have other types of risk like liquidity risk, default risk, credit risk etc. The point here is that there needs to be a clear quantitative value attached to these types of risk. I shall write something more on risk a little later....
  • Returns: This is the residual that you get when you have clearly defined the above mentioned factors. If you are a person who looks at investment conservatively, then the risks that you take are on the lower side, hence the degree of safety is higher making expected returns to appreciate to be smaller.

Now lets look at the products that I fancy...

There are tax savers such as PPF, an excellent product considering that the interest rate is guarenteed by the government and the government is always pro-citizen. But then this product is least liquid. I will always invest in this product apart from my employers contribution in this fund. This will be a long term investment for me and it shall be a small part of my portfolio.

Post Office Savings Scheme is another product that one could invest. Though it is not guarenteed, the government would force the post office to provide higher rates of interest to promote savings. Again, there are problems with liquidity.

Reserve Bank of India Bonds: This is my another favorite instrument incase I do not want to have any risk and I want something better than Fixed Deposits. Though this investment is taxable, it still gives something better than FD's. This is a completely risk free product as it is backed by RBI and the possibility of it defaulting either interest or principal is infinitesimally small. An investment which is completely illiquid and you can not pledge this instrument. Extremely useful incase you are on higher income bracket and have completed all other safe products like house(s), precious jewellerly.

Money Market/Debt Mutual Funds: The final product and I do not prefer investing in anyother form of safe instrument for short periods of time. Here, time period is anywhere from one day to probably three years. The broad ranges of products that you get in this is simply amazing and this is probably the least understood of all products. Money can be invested in a liquid fund, incase your time horizon is less than a month and short term debt funds for less than a year and long term instruments for more than a year. It works the same way of a Fixed Deposit, except that this is not guarenteed. There is however a catch in this product and that is only for the long term debt products. As investments is made in securities the ideal time to invest in this is when economy is in recession and when it is just coming out of it. A poor product to invest when economy is in full swing.

Equity: The safe haven for investing when your time horizon is less than five years. A wonderful place and a little active participation has made me understand that this product can be invested for years and the longer that I stay the better returns that I make. To me, it is a nice feeling of owning a company and even better if I can see my wealth accumulate better than other debt products. I prefer taking risks that I can bear with and though I do not set goals when I invest in equity, I like to follow a Warren Buffet style of investing. To invest in a stock like owning and working for the company.

Equity Mutual Funds: This is another place where most of my investments will be if I am not in a position to devote a lot of my time on stocks. Also, this product is useful as the fund managers' access to information is better than as an individual. There is a problem with this though. Fund managers are tracked very closely and they tend to take calls on companies that are safer. However, I believe that this will be better than not investing in equities at all.

I shall explain my investment philosophy with every product in more detail later....

1 comment:

D.Raw El Payne said...

I shall explain my investment philosophy with every product in more detail later....

yay!!! I can't wait to not read that!