Similarly, before investing in any product, you must evaluate and assess it. As I have explained in my latest publication 'Your Guide to Finance and Investments', there are typically 5 parameters to do so viz. Returns, Time Frame, Liquidity, Risk and Taxation.
Though extremely straightforward, many mistakes happen in their real-life application. So let us try and get a better understanding.
Returns : Some products, like Bank FDs, give a pre-agreed rate of return. So no issues here... you know how much you will earn. But income from many products, such as property or equity shares, is not known beforehand. It depends on the market. In such cases, you have to make some reasonable assumptions. However, the more conservative you are, the better it is. For example, long term average return from equity has been 17-18% p.a. So it would be unwise to expect say 25-30% p.a. yield from shares.
Time Frame : This will tell you how much time you have to normally remain invested in the particular product. In some cases, like Bank FDs, the exact tenure is known in advance. But many products such as savings account or property have no fixed tenure. Here you have to make reasonable assessment. Savings account money can be withdrawn anytime anywhere. But if you are buying property, at least 3-5 years of holding period is prudent to derive the best benefits.
Liquidity : Can you pre-maturely withdraw your money from a particular investment? If yes, it is very liquid... like your savings account. But a 5-year tax-saving FD is totally illiquid. You cannot touch it at all until maturity. Your portfolio should be liquid enough to match your requirements.
Risk : Default risk, interest-rate risk, market risk, etc. are some of the risks that come with any investment. It is important that (a) you choose those investments that match your risk profile and (b) you take appropriate precautions to, as far as possible, safeguard your money.
Taxation : It is but natural that you have to choose those investments where your effective returns, after paying the applicable tax, is higher. For example, 9% FD with 30% tax means effective returns of 6.3%. Whereas 8% FMP with 10% tax makes a better investment with 7.2% effective returns.
I am deeply pained to see that people suffer from bad products as they do not go through this simple 5-parameter assessment to make sure that they are buying the best. Since your time-frame, tax profile, risk appetite and liquidity needs are different from others, you should not blindly invest where others are investing.
For your convenience, in my aforesaid book I have evaluated 51 of the most common investment products on the above 5-parameters and summarized each in a easy 2-page format. A few of these can be perused here.
