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Session 9: Making Productive Investments

We are glad to have you with us for our Ninth Session - Making Productive Investments

Alright so now let's get started.

We strive hard all our life to make money so that we can fulfil our dreams and that of our family. And in order to fulfil these dreams, we often invest the money we save. While that's a good habit and one should continue with it; the question is, "are you making productive investments?"

You see, investments need to be made prudently, so as to yield fruitful returns for you, or else your dreams could be farfetched and not turn into reality. While in one of our earlier sessions we introduced you to various asset classes - equity, debt and gold; in this session, we'll take you through how to make productive investments.

Let's first quickly brush-up through some important points we have already learnt in our earlier learning sessions.

What is Savings?

In simple terms savings means...

  • The money left with you after paying for all your expenses and liabilities (...Therefore your unspent income results in your savings. To put it simply...)

    Savings = Income - All expenses (including obligations towards borrowed money)

But the question is, can savings alone be sufficient to fulfil your dreams?

The answer is a very simple NO!

If saving was sufficient enough to fulfil your dreams, then there would have been no need to invest. Everyone would have kept their savings in their lockers. But the hard truth is that your savings will lose its value if you don't invest...and more importantly if you do not invest wisely!

So now let's have a look at what is investing...

What is investing?
Investing means...

  • Productively utilising your savings with an expectation of earning return over and above the rate of inflation.

Investing is a...

  • A process of making your savings work for you (...instead of simply stacking it in your vault or bank locker.)

Now we all know that you need to invest your savings, but the question arises, where?

Well, here are some of the investment avenues where you can invest your savings...

Some Well-known Investment Avenues

(Asset Class wise...)
  1. Equity (...It simply entitles you to become one of the shareholders of the company, so you have a share in both company's profit and losses. Equity investing offers you an opportunity to earn income in the form of dividend distributed by the company or in the form of long term capital appreciation. But do not forget equity investing carries high risk as well.)

  2. Debt (...The way you take a loan from a bank and pay interest on it, the same way the bank or any other financial institution borrows money from you and pays you interest. So the money you lend someone for earning an interest income is your investment in debt. Debt investing is safer than equities but it does carry some element of risk.)

  3. Gold (...It is a precious metal and used not only to make gold ornaments but also to preserve value of money, as it is considered a hedge against inflation. The value of your investment in gold may change based on the prevailing market value of gold, but it does not offer you any regular flow of income.)

  4. Real Estate (...Today, when we talk about real estate we not only talk about a house to live in (or primary home), but also approach it as an investment which can provide us price appreciation and / or rental yields.)

You see, knowing the asset class is as important as knowing which asset class suits your requirement the best. This is because all asset classes have their share of pros and cons, and hence it becomes imperative to know each of them on various traits, before investing your hard earned money.)

Key Points to Consider before Investing in...

(Equity, debt, gold and real estate...)

Traits Asset Classes
Equity Debt Gold Real Estate
Return High
[Capital Appreciation & Dividend Income]
[Interest Income]
[Capital Appreciation]
Medium to High
[Capital Appreciation & Rental Income]
Risk High Moderate To Low Moderate High
Liquidity High Medium Medium Low
Taxation* STCG# - Taxable
LTCG## - Non Taxable
Interest Income-Taxable Capital gains-Taxable Capital gains- Taxable
Rental Income-Taxable
Suitability For long term Investors having high risk appetite For short term Investors having low risk appetite For long term Investors having moderate risk appetite For Long term Investors having high risk appetite
#: Short Term Capital Gain Tax
##: Long Term Capital Gain Tax
* As per current tax laws. Please consult you advisor for implications of the investment/participation in the aforesaid asset classes.

The table here compares the various parameters for each asset class we just talked about.

You see, while equity offers you opportunity to earn high returns, it comes with high risk. It offers you high liquidity and favourable tax status as well. Thus if you have high risk appetite with longer time horizon, then this asset class may be suitable for you.

While if you are conservative, then you might feel like investing only in debt as it has a low risk status. But do not ignore the other aspects of investing in debt - like taxation, liquidity etc. The interest income is taxable. Moreover, with low returns clocked by debt instruments, you may not be able to beat the inflation rate thereby eroding the purchasing power of your money.

Gold on the other hand has the ability to offer capital appreciation, but at times it may be risky.

Real estate should be considered primarily for your own dwelling and then for investment. Though it involves high cost and low liquidity, it offers you an opportunity to earn a second income in the form of rent.

So as we said earlier, you should make your investments prudently. If you are unable to beat the inflation rate, then you may end up eroding the purchasing power of your money.

Now you may be wondering how you will lose the value of your money; so to understand it better, let's take an example...

Can You Fulfil Your Desire?

Cost of your Favourite Car today = Rs. 5 lakh

Assuming Inflation @ 10% p.a.

Cost of your Favourite Car after 1 year = Rs. 5.50 lakh

(Inflation @ 10% p.a. is used for illustrative purposes only)

Say your desire is to own the latest model of a car, which costs Rs 5 Lakh today. But you decide to wait for 1 year and then purchase it. Mind you, if inflation grows at the rate of 10% p.a., the cost of the car you dreamt of owning may move up to Rs 5.50 lakh. So to fulfil your desire of owning this car, you need to have Rs 5.50 lakh after 1 year.

Your Investment in a Fixed Deposit for 1 year = Rs. 5 lakh

Expected Rate of Interest = 8% p.a.

Maturity Value of Fixed Deposit after 1 year = Rs. 5.40 lakh

(Rate of interest of 8% is used for illustrative purposes only)

Say you have a saving of Rs 5 Lakh. Now since you are planning to buy your favourite car next year, you choose to invest your savings of Rs 5 lakh in a bank fixed deposit earning interest at the rate of 8% p.a.

But at maturity - a year later - your money in the fixed deposit will have grown to just Rs 5.40 lakh while the cost of your favourite car will be Rs. 5.50 lakh in that year. So you may end up with a deficit of Rs. 10,000... and not to forget, after paying the applicable taxes on your interest income, the money in your hand will reduce further.

It means the car which you could have bought today, may be worth more than the amount you may have after 1 year... In simple words, if you do not make productive investments, the value of your money or we can even say the purchasing power of your money will decrease with time.

Now let us move a little further...

How to Achieve Long Term Financial Goals?

Asset Allocation (...Asset Allocation is a very important strategy when it comes to well thought out Investing. Investing with a prudent asset allocation will help you appropriately plan your finances and make sure that you earn the desired result after investing a certain percentage of your money in each asset class.)

Diversification (...By diversifying your investment, you will choose to invest not only in 1 type of asset class, but different asset classes and even different types of instruments within a particular asset class. Diversification will effectively help you reduce the risk on your overall investment portfolio.)

Power of Compounding (...For your money to multiply manifold, you need to invest for longer periods. The higher the returns and longer the time horizon, the higher will be the compounded growth of your investment.)

To understand productive investment better, let us see the historical growth of two popular asset classes equity and gold.

Now let's see how equity and gold have performed over a period of 15 years to have an idea of which asset class performs the best in the long run.

Investing Wisely Helps!

Investing Wisely Helps!
Source: ACE MF
Note1: The value of equity investment is derived from the performance of S&P BSE Sensex - TRI,
Note2: While the value of gold investment is derived from the performance of Gold-London AM (INR)
Past performance may or may not be sustained in the future.

The graph here shows that if you had invested Rs. 10,000 each in Equity and Gold on 30-Oct-1998, then the value of your investments in gold and equity would have been Rs. 66,078 and Rs. 97,590 respectively as on 31-Oct-2013...

It means that over a period of 15 years your returns in Gold would have grown at the compounded annual growth rate of around 13% while your investment in equity would have grown at the compounded annual growth rate of around 16%. So your investment in equity would have outperformed gold by around 3% p.a.

Not all asset classes have the potential to deliver inflation beating returns in the long run. So in order to make productive investment, you need to choose your asset class wisely. Or else you may not be able to even beat the rate of inflation and loose the purchasing power of your money, thus missing out on some of your important financial goals.

So What do we Understand?

Equity - One of the Best Asset Class in the Long run Even though you might see some ups and downs in equity in the short run; over the long run it tends to outperform all other asset classes. You can earn income via dividends as well as capital appreciation.
In the long run, equity helps you earn a return better than the inflation rate, which means your money should actually grow at a better pace rather than depreciate.

Debt - Preferred Asset Class in the Short run
Debt might not be able to give you high returns and may not have the potential to beat the rate of inflation; but it may make sure that your principal amount is protected against market volatility (on the condition that you hold it till maturity). It offers you a regular flow of income but at lower rates. So if you are looking to park your safe money for a shorter time period, then debt will be an ideal asset class.

Gold - An Asset Class to Preserve the Value of Money
Gold is considered as a hedge against inflation and will help you preserve the value of your hard earned money. It may not help you with a regular flow of income.

Real Estate - An Asset Class to serve your Basic Needs first
If you plan to buy a self-occupied house then anytime is a good time, as purchasing a home is more an emotional need rather than an investment. You should not consider real estate as a preferred investment asset class unless it fulfils your own basic need for shelter. It is best to ignore your self-occupied house as your investment. The other property that you hold may however be considered for regular flow of rental incomes or capital gains.

Finally before we wrap up today's learning session, here are some points you must keep in mind to make productive use of your investments...

Points to Remember

  • Just investing your savings is not enough. You should invest wisely! (...As inflation will reduce the purchasing power of your money, you should be making productive investments, which can counter inflation better and create wealth for you to meet your long term financial goals.)

  • Know the pros and cons of the asset class before investing (...Merely investing in an ad-hoc manner, may not be good for your long-term financial well-being.)

  • Less risky assets may not be able to beat the inflation rate (...So to earn positive real rate of return, asset allocation and diversification is necessary.)

  • Equity has potential to generate high returns in the long term (...Please note that, even though equity will show some volatility in the short term, in the long term it may counter the inflation rate and potentially give you a better positive real rate of return.)

  • Debt is suitable in the short term (...Invest in safe debt instruments if you are investing for the short term and safety of principal is your main priority. Do not forget, not all debt investments are safe.)

  • Gold is considered a hedge against inflation (...It will preserve the value of your hard earned money, but may not offer you any flow of income.)

  • Real Estate should fulfil your basic needs first (...Consider real estate for investment only after having one to meet your basic need like shelter.)

So to end our today's learning exercise we now invite you to test your learning by taking up this simple quiz (and win exciting prizes!)

Just Click On The Link Below

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Disclaimer: The contents of this document are only for informative purposes and are not to be used or considered to be an offer to sell or buy units of Franklin Templeton Mutual Fund schemes. This video is for information purposes only, provided on an 'as is' basis. Nothing in it should be construed as personal financial advice. You are responsible for your own investment decisions and you should seek advice concerning suitability from your investment adviser regarding any of the investments mentioned. The video is for personal non-commercial use only and may not be copied, stored, redistributed or broadcast in any way. We recommend you read the complete Terms of Use.

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