Investments for an Individual: Need and Procedure

Normally, it is advocated that 5-10% should be allocated into gold, 5-10% in insurance, 30-50% in fixed deposits or government or corporate bonds, and rest in equity, and silver and other inflationary commodities, opines Tarun, in the weekly column, exclusively in Different Truths.

Indians are considered people with the highest tendency to save. The country’s savings rate is amongst the highest in the world, more than 30%. It is not for no reason that we became a bird of gold in the past. And channelising those savings for further returns of money is a national pastime. Let’s see the various options that are available, and how the average person can benefit, and optimise the returns.

Let’s define savings first. Savings means income that is not spent on consumption. Sounds simple, doesn’t it? Logically, all people should be saving money, by spending less than they earn. But is it that simple? Let’s examine that.

Money has a psychological basis. I did an experiment once. I moved around in Delhi, with merely a 100 rupee note for an entire week. Although I didn’t spend that entire note at the end of the week, believe me, it was really painful to think of buying even a bus ticket, as that would have reduced my available money. Similarly, I tend to overspend if I manage to get more money than I usually have. That happened with my first outing with a credit card. I bought handmade soaps, fragrances, and incenses, which I had not planned for. There’s a study that says a person coming into money suddenly, say a big lottery winning, is worse off financially about 10 years down the line than he was before winning the lottery. Thus, a person would be in psychological balance if he maintains the balance of money he normally has. Reduce the amount, and he would become anxious. Increase the amount, and he is likely to become careless. The sudden increase won’t help him much.

The upshot of above is, that money has to be cultivated in a manner that doesn’t disturb our psychological balance. This would maximise a person’s happiness, which is the highest pursuit in life.

As said earlier, saving is a surplus of income over expenditure. What psychology helps us save money in the first place? That is the psychology to put off gratification. The more one is able to postpone one’s need to gratify the senses through consumption, the more one is able to save. Mind you, I am not saying that one should not consume in life. Consumption increases pleasure. Pleasure is related to senses, as different from happiness, which is related to consciousness. Pleasure is ephemeral, or temporary, as senses tend to want satiation, whereas, happiness is satisficing, that filling the feeling of having achieved a thing of permanent value in life. This is a little philosophical, but if one thinks deeply, it is all related to what one is going to do with money in life, or even how one is going to be attracting money in life.

After we have managed to master the art of savings and become stable in our income and expenditure, comes the problem of putting that money or savings into optimum investments. By optimum, I don’t just mean maximisation of returns, but maximisation of risk-adjusted returns. These risk-adjusted returns make an investment portfolio achieve its goals, and make the investments sustainable. Let me explain risk-adjusted returns.

There are various instruments into which money can be invested, and allowed to be increased. Some of the common avenues can be like fixed deposits of banks, government bonds, company debentures, gold, silver, stock markets, and fancy derivative products like FMPs. Then there is real estate, and there is insurance of course.

A government bond carries the highest safety of principal amount, and interest payment. Fixed deposits in banks are very safe too. The private company debentures are carrying a higher coupon rate, but they are also riskier in terms of principal and interest payment. There are rating companies that rate these instruments, and the higher rating means more safety than lower rating ones. Gold is a very interesting asset class. It has no guaranteed return. Yet, it has a very low volatility index and acts as a good inflation hedge over a period of time. Silver is much more volatile than gold, but is also investible, as it acts as an industrial metal as well as a good inflation hedge too.

Now, stock markets are the most volatile asset class. But they also have the capacity to deliver big returns over a period of time. Here, an investor has to choose between various individual stocks too. Or one can invest in the whole index. This index absolves the individual of taking on individual stocks. One can simply invest in units of Nifty, which reflect the blue-chip stocks of the day.

Real estate is very stable, offers a very good inflation hedge, but has a very poor liquidity built in. In tough markets, getting to sell real estate can be a big pain. Insurance again is more to protect one, as a bonus paid is usually less than interest component of fixed deposit, although insurance offers taxation benefit.

So, this is what one can do with savings. The risk-adjusted return is usually measured by statistical tools such as Sharpe ratio. An investment, though offering a lower return, can have a higher Sharpe ratio because of lower risk or volatility, and thus can be preferred over an instrument offering a higher absolute return.

Since various instruments offer different advantages, an individual would do well to start investing in a mix of them, to offer the best combination of safety and returns. That is, the portfolio should statistically have the highest Sharpe ratio. Of course, the individual’s age, investment goals, and the time horizon would determine the ideal portfolio. Normally, it is advocated that 5-10% should be allocated into gold, 5-10% in insurance, 30-50% in fixed deposits or government or corporate bonds, and rest in equity, and silver and other inflationary commodities.

The main thing is to start saving early, even though it may be small. The time value of money will take care that even small savings turn into big fortunes.

©Tarun Gupta

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