Investment 101 — Think beyond cash and saving account
Special Products Offered by Banks
When I was young and started thinking about “saving” my money, then I only thought of 2 mechanisms — 1) Cash and 2) Money in bank account. The understanding and knowledge of investment started coming in much later. As a kid I had a small piggy bank which I would use to deposit every amount I received from my parents, hoping that the saving would one day aggregate to become a large enough amount to make me rich.
Little did I realize that the physical money was not growing, rather it was declining (due to inflation). When I grew old enough to have a bank account, I started thinking of saving as well as slightly growing my money using saving rates offered by the banks.
These savings rates differ from country to country, but growing in India, the rates offered by banks were somewhere around 3–4%. While that gave me a notion of my money growing, that was still a false notion, as the inflation rates were much higher than that. So, my money value was still declining!
I realized over time that this was not just me, and a lot of people who do not understand the options available to grow their hard earned money end up with this 0 (or very low rates of return).
The sooner we realize that this does not help us make “money from money”, the better it is for our financial health. $ 10,000 invested for 30 years at 10% annual growth rate becomes $ 174K, while the same money kept as cash for 10 years and only invested for the next 20 years becomes $ 67K — Almost $ 100K difference
In this blog, I will share some of the alternate options which are available for retail investors to not just save, but invest and grow their money. Let’s see in the order of Low Return / Low Risk to High Return / High Risk. I will focus on equity stock market based
Special Products Offered by Banks: These include Fixed Deposits, Recurring Deposits, Private Provident Funds. At the time of writing this blog, the interest rates offered by these products (in the Indian context) range from 5% — 8% pa These are moderate return and low risk products, hence offer a great alternative to those investors who prefer to take very low risk
Index Funds: An Index fund replicates the stock market index of a country (and is representative of a portfolio of largest stocks in any economy). The number of stocks which are considered for calculating the index differs from country to country.
As an example, Nifty50 is an index of India which represents 50 of the largest Indian companies listed on the National Stock Exchange. Similarly each country has an index fund of their own which represents the biggest stocks listed on their exchanges (eg S&P 500 for US, FTSE for UK, DAX for Germany, CAC40 for France and so on).
Given the index funds reflect the share price of the largest stocks in a country, they offer the advantage of investing in the stock market with a low — medium risk .For investors who want to enter the stock markets and test the waters before expanding their investments, this is usually a great place to start
Mutual Funds: Mutual Funds are a slightly different variation of index funds. They are similar to the extent that they are also a portfolio of stocks (or other assets), but different in the sense that they usually have this portfolio around certain specific themes.
Examples include large cap funds that have a portfolio of stocks of companies with large market capitalization. Similarly, mid-cap / small-cap funds invest in stocks of medium / small size.
Mutual Funds can be sector specific as well, eg Tech funds focusing on Tech stocks only. Mutual funds offer medium risk and medium returns (can significantly vary across different mutual funds). For investors who already have investments in index funds (or even in parallel)
Large cap individual stocks: This implies investing in stocks of large individual companies (e.g. Google, Microsoft, Amazon and all the other big names you keep hearing every day). these offer medium-high return with medium-high risk.
Being well established business, the chances of these large companies down is low, as they have strong and sustainable business models. However, since you are relying on a single company (vs. index or mutual funds which track multiple companies at a time), the risk is still there
Medium-Small Cap individual stocks: These include stocks of companies which are listed on stock exchange, but are medium to small size in nature. They offer high risk and high return.
High return because if these companies grow well, there is benefit of starting from small base (growth of a company from $ 1Bn to $ 10Bn makes your money grow 10-fold, vs. growth of the company from $ 10Bn to $ 20Bn only makes the investment grow 2-fold). At the same time, risk is also high because these companies are not as established as the large ones
Alternate investments classes: The world of investments is not limited to only stocks and savings (or other special accounts offered by banks). There are many alternate classes of investments available, such as cryptocurrencies, commodities, derivatives, interest rates, Forex, bonds and moneymarket etc.
I will not go into the details of these in this blog as these are rather complex investments and require higher investor savviness . As an early investor who is just starting, I recommend not to consider these in your portfolio. These can be included over time as one learns and navigates the investment world
Now the biggest question for every early investor: What should I buy?
It is very important to take a portfolio approach, rather than thinking about only investing in one category or 1 stock vs. other. A portfolio approach typically means investing in different categories with careful planning of% allocation in each category.
As I mentioned early, if you are starting to consider investments, then better start safe and invest in Index Funds / Mutual funds which offer inbuilt diversification. Over time, it is important to properly balance your portfolio in a way that you take calculated risks to offer you opportunities for higher rates of growth also.
This means including individual stocks as well as alternate investment classes in your portfolio (but with a limited allocation of your assets). I will cover the portfolio planning topic in my next blog.
I am a business person with strong consulting, sales and operations background, and high affection for technology. I also provide advice / consulting to small / startup companies on request.