The main purpose of this article is to make you familiar with different available investment asset classes that an investor can invest in. Due to lack of investment knowledge, majority of the people are aware of only three most common traditional asset classes i.e. gold, real estate, and very popular fixed deposits. However, there are various other investments that can give better returns than these traditional asset classes. We will be discussing all this in detail but before moving ahead let’s understand the two basic questions.
Q. What is an Investment Portfolio?
An investment portfolio is a group of assets that an individual or a company holds with the purpose of earning returns on it. It is always suggested that one should have a diversified portfolio in order to minimise the risk and maximise the returns.
In the finance industry, it is usually said “Higher the risk, higher the return” and hence each asset class have different risk and return profile.
Q. What is a Diversified Portfolio?
Portfolio diversification means one should maintain a portfolio in such a way that one asset class compensates for the loss of another asset class which in turn reduces the risk of losses and protects the investor from relying on a single asset class.
There are broadly five major asset classes that you can invest in to diversify your portfolio and earn returns according to your risk appetite.
Let’s understand different asset classes and the instruments which one can invest in.
1. Fixed Income/ Debt: This asset class gives a fixed return on the principal amount deposited. Usually, these returns are pre-decided. Following are the fixed income instruments:
1.1 Saving Bank Account: The returns are fixed and usually between 4% to 6%. The risk is very low as banks are regulated by the central bank of the country.
1.2 Fixed Deposits: The returns are usually between 6% to 8%. The amount deposited under FD is blocked for a particular period. The risk is similar to that of saving bank account.
1.3 Government Bonds*: These bonds are very safe as they are issued by the government. The principal amount is blocked until the bond is matured. The average return on such bonds is between 6% to 8%. Usually, government issues such bonds when there is a need for funds in order to finance government projects.
1.4 Debentures*: These are very similar to a government bond where the public or private companies issue debentures to the general public for a fixed return of somewhere between 7% to 12%. The risk is usually high, as due to any unforeseen situations the company might not be able to pay back the principal amount.
(* Bonds and debentures are financial contracts issued by companies or governments to raise funds for a fixed interest rate every year)
1.5 Public Provident Fund: These funds are backed by the government and have withdrawal restrictions to it. An investor is required to deposit a minimum of Rs. 500 every year and maximum up to Rs. 1,50,000 in order to get the benefit of excess returns. The return is as high as 8% to 9%. The risk profile is very low.
1.6 Debt Mutual Funds: Mutual fund companies invest in different debt instruments in the market such as debentures of companies or government bonds and create a portfolio, in such a way so as to minimise the risk and maximise the return. As this mutual fund deals with various debt funds, the risk involved is moderate to high. Average returns are between 7 to 11%.
2. Equities: So instead of giving money to someone and earning interest on it like we have seen in the Fixed Income part, in Equities, we are purchasing a piece of a company and becoming part-owner of that company. We can invest in the companies through different ways such as:
2.1 Company Stocks: We can directly invest in the companies by purchasing their stocks through the stock exchange and become part-owner of the company. The company’s share price will fluctuate and so will our portfolio, we might experience profits as well as losses depending on the fundamentals of the company and market sentiments. (Therefore it is always recommended to invest in companies which have strong fundamentals, such companies will never give negative returns in the long run, for more understanding you may refer: How to choose good company stocks?) The risk involved is high. The average expected return can vary from 15% to 25% on long-term holdings. As company stocks are highly volatile and cannot be predicted, hence the returns can be as high as 100% and can also be as low as -100%.
2.2 Equity Mutual Funds: Here Mutual fund companies invest in equities of multiple companies in different sectors and create a portfolio so as to minimise the risk and maximise the return. An investor can earn returns on an average of 10% to 20% on such mutual funds. As they are diversified funds and managed by professionals, hence the risk profile is moderate, (it might vary depending on the portfolio). One should check for expense ratios charged by the mutual fund companies before investing in any funds. One major advantage is that they provide a "Systematic Investment Plan" also known as SIP which takes care of our investment on a monthly basis. we do not need to manually invest in the fund every month, we can fix the monthly investment amount and choose the SIP option which will auto-debit our account on a monthly basis. Mutual funds are a good investment asset for people who are not an active stock market investor.
2.3 Exchange Traded Funds: ETFs are a portfolio of multiple stocks that are been traded on the stock exchange. This is similar to equity mutual funds except for the fact that these funds are traded on the stock exchange and are not provided by any mutual fund companies. They don’t have any other charges, unlike mutual funds. They don’t have a SIP option, Hence an investor will need to manually invest a lumpsum amount. The average return is around 10% to 20% on long-term holding. The risk profile is moderate to high.
3. Real estate: Everyone must be might be aware of real estate investment and how lucrative the returns are. Normally the value of land and property appreciates but from the past few years the real estate market is performing very poor. However, being an optimistic investor, we hope to get back the average returns in the next few years, and hence below analysis is based on past returns. There is one more interesting real estate investment that one might not be aware of i.e. REITs. Apart from these all the Real estate investments have a risk profile of low to moderate.
3.1 Residential house: The average return is 8% to 10%.
3.2 Commercial Shop: The average return is 10% to 15%.
3.3 Land/ Plot: The average return is 10% to 12%
3.4 REITS: Known as "Real Estate Investment Trust" is a pool of funds managed by professionals who invest in real estate on behalf of investors. They allot units to a particular investor for the amount contributed by them in the fund, it is very similar to a mutual fund. Later the rental income received from real estate is distributed amongst the investors in the form of dividends. They charge some managing fees for their services. The average return is somewhere between 8% to 15%.
4. Gold: It is considered as one of the traditional and risk-free investment assets. There are studies that show negative returns in some rare cases, but when compared with past data, gold have always given positive returns of somewhere between 5% to 9%. There are three forms in which an investor can invest in gold and all three have the same risk and return profile.
4.1 Physical Gold
4.2 Gold ETF: These are Gold funds, that are traded on the stock exchange. An investor can buy gold funds and hold them in their DEMAT account, he doesn’t need to hold physical gold to avail the appreciation benefits.
4.3 Gold Mutual Funds: Here Mutual Fund companies invest in gold and allot units to the investors as per the amount they wish to invest. In order to hold Gold mutual fund, you don’t need a DEMAT account.
5. Cash and cash equivalents: (Also known as money market instruments.)
5.1 Cash: Do you know stacking up cash can give you negative returns? For example Holding Rs. 100 in cash will be the same even after 10 years but the value might decrease because of inflation, you cannot buy the same product for Rs.100 today, which you could have brought it 10 years ago for the same price.
5.2 Liquid Mutual Funds: These Mutual Funds are similar to cash as they are highly liquid in nature. An investor can withdraw his money instantly at any time. The return is very low, it is somewhere between 3% to 6%. The risk profile is also low.
Disclaimer: All the above-mentioned average returns and the risk profile is based on historical data and can vary depending upon the market events. A high-risk profile asset class DOES NOT mean there are high chances of losing your money, instead it shows that there are some uncertain market risks, which cannot be controlled. Hence one should have proper knowledge about the advantages and disadvantages before investing in any particular asset class.
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