Monday, October 14, 2013

Know the 4 Dimensions of Investing

Investing and analysing investment options can seem burdensome, tiring, boring, confusing, hair-splitting to know everything about it before committing your money to it. Irrespective of what the brokers, sales guys, agents try to push to you as an excellent opportunity for you and your loved ones, it is important to know that they have an inbuilt interest in selling things to you and you have to do your own due diligence. Doing your own due diligence is often spoke about, but some of you may wonder what does this mean and how do you do it.
There are essentially 4 dimensions to understand any investment:
1. Return/Potential Return
I say return/ potential return and not just return so that you are not overly swayed by the superb past returns of an investment, but realise that not all investments will repeat their super duper track record time and again. There may have been a time and environment where something really made great returns, but this time and environment may well be very different. 
A plot in a far away village may not give you a great return on your investment without nothing new happening. But, once it is known that an international airport will be coming in the area, the investment may have great returns. And once all the development is done, the return on investment may not follow the run you saw during the days when the news of the airport was coming. Similarly with stocks. There are good times and great times for companies depending upon a myriad of factors such as demand for the product/service, cost of making things, saturation of product usage, etc.
2. Risk & Return
Each investment has a certain risk to it. Even Govt. owned companies and their shares/bonds have some risk in it. Nothing is risk free. Sometimes the risk is on the return, while on some others, the risk is on the capital deployed itself. One has be aware of the risks and consider the return on the investment proportionately to the risk involved. Derivatives are more riskier than Stocks which is more riskier than fixed deposits/bonds/gold.
Do remember that sometimes even a less risky investment can cause a major loss compared to a higher risk investment.
3. Liquidity
This involves multiple things and is very important but unfortunately not given much importance by many people. Liquidity refers to how fast can you to convert the investment to cash whenever you need it. Another related aspect to liquidity is whether the investment can be used as a collateral against which you can get a loan. Certain investments cannot be given as collateral and no loan can be obtained against them. E.g. Bonds, Fixed deposits in some NBFC (Non Banking Financial Company)s. Some investments may have a lock in period which will limit the ability to sell the investment. Certain bonds have a lock in period before which you cannot trade it in the market. Sometimes, holding a stock/bond that is not widely traded also brings about liquidity problems while trying to sell it.
4.  Tenor
The length of the investment period. At the end of the day, you will need to match the investment tenures to the life's various goals. No point in investing in a 20 year investment that is locked if you don't have money for your other urgent goals.
All investment avenues would have the above mentioned 4 characteristics. You should know these 4 aspects of your investment and competing investments before you make a decision to invest in one based on your life's goals and risk apetite.

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