What is investing?
The act of committing money or capital to an endeavor with the expectation of obtaining an additional income or profit. 
Why should one invest?
- Fight Inflation– While prices rise, there is not much change in the salaries people receive from their jobs. Investing helps us deal with the inevitable growing cost of living.
- Wealth Creation– Investing helps us create wealth for times like retirement or when more funds are required than the amount the person earns at a particular point of time. Example – Marriage, purchase of house, children’s education, etc.
Where should one invest?
The decision regarding where one would invest depends on two factors-
- The rate of return
- The level of risk
Risk and return have a positive relationship. Higher the risk, higher the return. Lower the risk, lower the return. A risk averse person will be disinclined to take risks while a risk seeking person would be more inclined towards taking risks to get higher returns.
When it comes to investing one has to choose an asset class that suits the individual’s risk and return temperament. An asset class is a category of investment with particular risk and return characteristics. The following are some of the popular assets classes-
1. Fixed income instruments– A fixed-income security is a debt instrument issued by a government, corporation or other entity to finance and expand their operations. These instruments include fixed deposits offered by banks, bonds issued by the government, by government related agencies and by corporates. At the end of the term of deposit, the capital is returned to the investor.
Return: Not very high. Paid as an interest to the investor based on the particular fixed income instrument.
Risk: Limited, as it is very unlikely for these institutions to fall.
2. Equities or stocks– Investment in Equities involves buying shares of publicly listed companies. The shares are traded both on the Bombay Stock Exchange (BSE), and the National Stock Exchange (NSE) in India.
Return: Very attractive, can be very high
Risk: No capital guarantee i.e. return can be negative
You may also be interested to know that the returns generated over a long term period (above 365 days, also called long term capital gain) are completely exempted from personal income tax. This is an added attraction to investing in equities.
3. Cash and cash equivalents– These include cash and short term liquid securities such as government issued securities, banker’s acceptances, euros, commercial paper.
Return: Not very high
Risk: These are considered the safest.
4. Alternative investments– These include commodities, real estate, private equity and hedge funds.
Owning investments with a mix of the asset classes, which is called diversification, can help in reducing risk and ensuring decent returns. The ratio in which one allocates investments across asset classes is dependent on the risk appetite of the investor. The combination of different asset classes that you invest in is called a portfolio.
I hope you have understood the basics behind investing. Do look out for the next post which will be about the stock markets in India and more on investing.