Basics of Investment
The first video in this series captures the basics of various investment options - from Stocks, Digital Gold, Mutual Funds to Real Estate and more in a fun and friendly manner. So if you’re thinking of starting your investment journey anytime soon, we’ve got you covered!
Want to learn about investing? Well, you’re lucky. Because back when I started, I only had books and magazines to rely on. But now you can watch videos and even read about it online like this.
So, Welcome to our new series - Learn With Upstox.
Maybe you want to invest in gold or in stocks or in mutual funds or IPOs or real estate, Whatever it is that you need to learn, we are going to explain it to you in a simple and understandable language.
In this article, we’ll talk about all the popular investment options available.
Someone rightly said, “Wealth is not built by saving. It is built by compounding.”
We often think that we should save some money, in our savings account or in cash, which will help us during emergencies or retirement. But we also forget that saving money as cash only reduces its value in the future. This happens because of inflation, when the price of things keeps increasing in the market.
Think about it this way - the same thing which you could buy for under Rs 1000 in 2002, can you buy it for the same amount now? No, right?
That is why we need to invest. So that we can be ready for our retirement as well as be able to fulfil our future goals.
The Power of Compounding
If you were given a choice - to either get Rs 10 lakh rupees right now or to get one paisa today, which will double everyday for the next 31 days, what would you choose?
If you chose to get Rs 10 lakhs, you’d have lost Rs 90 lakhs. Instead, if you chose the one paisa a day option, you’d become a millionaire. Yes, a millionaire.
To see how that works, Let’s learn an important concept which works like magic - The Power of Compounding.
Compounding basically works in a way which not only allows you to earn interest on your principal amount but it also allows you to earn interest on your interest as well. But this strategy only works for long term investments and requires you to be patient.
When you put away our money in fixed deposits, you think that you are earning a lot but that isn’t really the case. In fact, you should only invest in a FD when you don’t want to take absolutely any risks. Because FDs won’t make you ready for retirement. These days, banks don’t give a lot more than 6% of returns, which is usually how much inflation takes place.
So you need to understand that:
- Fixed Deposits don’t really provide good returns in the future.
- If you redeem the FD before it matures, then the penalty will cost you pretty much all the interest that was earned.
For example, if my Rs 12,000 FD was going to return me Rs 16,000 in 5 years, but if I redeem it within three years, then I’ll only get the Rs 12,000, not any of the interest that was earned.
Now, let’s move on to the next asset class and see how that’s different from the other asset classes.
Did you know that almost 11 to 12% of gold in the world is found to be with Indian women? But, is it the right option for investing? Can we even call it an investment?
Also do you think that buying physical gold is the only option of investing in gold?
When we invest in physical gold, we need to take care of many things and manage quite a few risks like:
- The fear of theft
- The fear of losing it
- Additional making charges and 3% GST
- Cannot be bought in small quantities as well as
- No monthly or annual interest payments
To combat all these negatives, Digital Gold was introduced.
When you’re buying physical gold, you have to pay Rs 5000 if you want to buy one gram of gold. On the other hand, if you want to buy digital gold, but only want to invest Rs1000 you can easily do that by sharing the amount with four other people who also want to do the same. This way, you invested in gold, but you only paid the amount of money that you wanted to pay, instead of some fixed amount.
With Digital gold, you also don’t have to worry about safety as that is looked after by the company where you got the gold from.
You also don’t have to worry about the making charges as these digital coins are held by the company.
But digital gold also has some disadvantages. Let’s see what they are.
- You still have to pay 3% GST and
- Still don’t get any regular returns.
To solve even these problems, another method is introduced.
The Sovereign Gold Bond
The benefits of a sovereign gold bond is that:
- It provides 2.5% of annual interest payment
- It doesn’t require you to pay the GST and the best part is that
- It can be traded like shares
Now, let's move on to the next asset class.
Bonds and Debentures
Whenever a company needs money, it can get funding from two ways:
- The first is Equity Financing, in which the owners of the company sell off their shares in the market. Which means that if the owner has 100% of shares in the company and wishes to liquidates 10% of them to the general public, he or she can try to do so via an Initial public offering or IPO. But if the company doesn’t want to sell its shares, it has another option.
- Debt Financing. In this, the company can either take a loan from the bank or issue bonds and debentures. And when the normal public invests in these bonds and debentures, the company gets money.
Generally people have this misconception that bonds and debentures are the same thing, so let’s take a closer look.
The similarities between Bonds and Debentures
Both of these are a type of loan for any company. And they both have a fixed interest rate on them. Also, this loan is for a strictly fixed period of time.
Then what makes them different?
The differences between Bonds and Debentures
Bonds usually come in the category of secured loans. This means that when the company issues the bonds, it keeps something as collateral.
On the other hand, debentures can be secured as well as unsecured. We can take the example of personal loans for unsecured debentures, in which collateral is not required but the interest rate is quite high.
Even if the company is going to be liquidated, the money which can be realised from the assets of that company will first be paid to Bond Holders. The priority is first Bond holders, then Secured Debenture holders and then Unsecured Debenture holders.
The next asset class which we are going to talk about is Mutual Funds.
This is an asset class which has become quite popular in the last few years in India.
Generally, when we invest in mutual funds we think that we are entering the share market. But that’s not the case. Through mutual funds, we can also invest in gold, real estate, debt instruments and equity.
Usually when people talk about the risk and returns of mutual funds, it seems like the risk and volatility is high so the returns must also be high even if it goes a little up and down. But this description is usually talked about in the context of equity mutual funds.
Let’s now understand,
How do mutual funds work?
So let’s say that you want to invest Rs 20,000 by yourself or through an advisor, and you’re told to invest in MRF or Page industries. But the thing is, even a single share of these industries is around Rs 80,000 which is way higher than what you want to invest. And this is the problem which arises when you go directly or via an advisor.
So, what does mutual funds do? Mutual funds will collect small amounts from many investors and pool it together. Let’s say it collected Rs 500 from around 100 people who want to invest, so now, mutual funds has Rs 50,000 with which it can buy two shares of Page industries. This helped you and many like you who wanted to buy shares but didn’t have the budget. Now, the question is - there are 100 people and only 2 shares, so what happens next? How will we split it? We won’t.
The mutual fund will keep the share to itself and instead give you a Mutual Fund Unit. What this means is that every person who invested gets a Mutual Fund Unit and all these people together become the holders of the share.
So basically, mutual funds allow you to invest in many companies using small amounts of money which you would not have been able to do had you invested directly.
How do Mutual funds do this?
Mutual funds are able to do this by making a fund management company. It is called an AMC or Asset Management Company. The company first launches a fund and then receives money from the people.
Let’s say that it launched a multi-cap fund. Which means that this fund will invest in all types of small and big companies. It will tell the investors that we have so and so experts, with so and so of track record who will manage the investors’ money. The fund tries to assure the public that they can give them good returns. Then whoever is interested, people like you and me, will start pitching in money. Some will give Rs 500, some Rs 1000 and so on. Now, all this money that is collected by the company is called the AUM or the Assets Under Management.
AUM simply means all the money that is collected. So if the fund had collected Rs 2000 from 50 people, it now has the total AUM of one lakh rupees. What it does next is appoint a fund manager. This person is an expert in picking shares and will make a strategy which points out the different shares where this AUM will be invested. Now that the AUM is invested, you’ll get the Mutual Fund Unit. And you can sell this unit whenever you want. If you sell it, the money will be transferred to your bank account within the next two days.
Let’s talk about Direct Equity now. In simple words, it means investments in the share market. Here, you invest in the shares of one company and then get a partial ownership of that company. Yes, if you buy a share of Reliance then you do become a partial owner of Reliance.
But generally, people always fear that investing in the stock market is very risky. So should you directly invest in the stock market without any advisor? Are there any benefits of investing directly in the stock market?
We know that equity, whether it is a mutual fund or a stock, certainly gives more returns than bonds, debt or FDs. But what we have to know is how direct equities do as compared to mutual funds. And when we do the comparison, we find out that equities are riskier than mutual funds but at the same time, shares give more returns than MFs as you choose the share and the returns depend on your choice. Sometimes, you can get more liquidity in stocks than MFs. Say for example that via mutual funds, you have twenty different stocks. But if you don’t want to invest in even two of these, you don’t have that in MFs but you can certainly do it when you directly invest in stocks.
The risk is more when you invest in stocks directly because you’re the one taking the decisions. But if you have good knowledge, then the returns can also be higher. You also get the autonomy to decide where you want to invest, where you don’t want to invest and the time when you want to invest in the market.
It’s time to talk about Real Estate!
In India, Real Estate has always been considered to be a conventional and popular asset in terms of Investment. If you buy a house, it’s value definitely increases over time and you can also get the rental income.
But if we check historically, real estate has only given upto 9 - 10% of returns annually. There are also some other disadvantages like.
- You can’t invest your small savings in it. You need an amount only in lakhs and crores.
- You don’t get liquidity in real estate. Which means that if you ever want to sell the asset, it’ll take you months.
Now, what about the house that you stay in. You call this your Personal Capital. So, is it good advice to buy an expensive house in hopes of increasing your personal capital?
The thing is some people consider homes to be assets while others consider them to be liabilities. Since you live in this house, you are definitely saving the rent and cutting back on the cash outflow. You could also get a rental income or mortgage the house to get a loan.
But your home could also be a liability. Because there could be cash outflow in terms of maintenance, repair charges, taxes, insurance, interest loans and many other expenses like these.
But India has always faced a scarcity of land and housing facilities because the population kept increasing. And since the population is high, the value of real estate will only keep increasing with time. And these days, buying a house comes with a lot of other facilities like clubs or pools or societies, so you’re not only buying a house but also an experience. And this experience that you’re buying along with your real estate is not an investment. In fact, it's an expenditure. The more amenities, the higher the expenditure and higher the monthly expenses. And that is why, the house that you live in doesn’t become a true asset.
And that’s all for this article. We hope that you have a basic understanding of how investment in different asset classes works. There are many such educational articles on our blog, so don’t forget to check. In fact, you could also check out our YouTube channel to do the same.
Thanks for reading.