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.
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.
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.
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.
About the Author:
The author Bimlesh Singh is a financial advisor. He holds a Bachelor's degree from IIT and is a CFA Level 2 candidate. He can be reached at email@example.com