- Different types of financial instruments
- What is your risk profile?
- Choosing the right financial instruments to invest based on your life stage and risk appetite
- Why you should take help of personal finance managers to plan your finances?
What are the different types of financial instruments?
There are primarily two categories of financial instruments, namely, the fixed income instruments and the equities. While the former offers fixed returns, the latter is more risky but better suited for achieving long-term financial goals. Here is a detailed look at the various investment instruments available in India:
1. Cash instruments
As the name suggests, a cash instrument is a type of investment that includes cash savings and instruments. The cash instruments include bank savings accounts, cash bonds, etc. These are highly liquid investments that help you to meet your short-term financial goals. It is very safe to invest in the cash instruments as practically no risk is involved here. However, the returns are also lower as compared to the other financial instruments.
2. Company and government bonds
Many corporate funds, as well as the government enterprises, require additional funds from time to time. This is why they issue bonds that are given to the investors. As an investor, you need to buy the bonds by paying a sum of money. This money is used by the company or the government towards their operation expenses. In return, you get a fixed return at regular intervals. When the bond matures, you receive the entire amount you paid, back. A company or a government bond is also a very secure form of investment that helps you to earn steady dividends in a low-risk manner.
3. Stocks and equity investments
Businesses raise money by selling their stocks and equities to the general public. The equities are sold at registered places such as the stock markets of the country. As an investor, you can invest your hard-earned money in stocks and equities and see your wealth grow. However, these investments are a bit risky. When the company performs well, you get to make profits on your investments as the stock prices consistently rise. However, if the company begins to perform poorly, its value drops and the stock prices begin to fall as well. At such a time, you stand to get very low and unprofitable returns from the stocks and equities. Similarly, when the economic condition of the country is poor, the stock markets crash and all the stock and equity investments begin to suffer. It is therefore wise for you to spread your investments over a number of stocks and equities and not invest all your money in a single stock. This is a factor you must remember before you invest in this financial instrument.
4. Mutual funds
Mutual funds are a type of financial instrument where the money of various investors are pooled in together and invested. As an individual investor, your money may not be sufficient to buy the stocks, shares or bonds. This is why you invest in a mutual fund to get higher returns. The yields and profits earned on the investments are evenly distributed to all the joint investors. The risk is lower and the chances of earning profits are higher as well. You can choose between three types of funds in a mutual fund investment – the equity funds, the fixed income funds and the money market funds. As is obvious, the equity funds carry the highest levels of risk, followed by the fixed income funds and the money market funds that carry the least amount of risk. You need to choose the fund carefully, after analysing your risk appetite.
An exchange traded fund, or an ETF as it is popularly known, is another financial instrument that is very well-suited for investments. Here, the benefits of mutual funds and equities are combined. You get to invest your money in diversified funds as you can do in a mutual fund. Then, as the name suggests, you can buy and sell the ETFs easily in the stock markets much like the equities. These features make the ETFs very popular and a common type of financial instrument among the investors.
6. Precious metals
Precious metals such as silver, platinum and gold act as excellent investment instruments. Gold, for example, proves to be a good investment platform. The price of gold rises continuously and consistently. If you buy gold worth Rs 10,000 today, you can sell it at a much higher price after a few years. Investing in precious metals is therefore a very common thing to do and is definitely something you must consider doing as well.
Apart from precious metals, you can also consider investing a portion of your money in property. It is always a good idea to buy some property in your own name. Apart from becoming a lifelong asset, a property also offers high returns on investments. Property prices appreciate regularly and so if you ever need to sell your property, you are quite guaranteed of making a profit.
8. Investing in businesses
Many small businesses look out for private investors who can support them with financial investments. If you have the kind of money they need nu are willing to take a risk, you can consider using a small business as an effective investment instrument. You can get the stocks of the company or you can agree to a profit-sharing arrangement. In either case, you can stand to earn huge profits against your investment, provided the business does well. You need to assess the business model and see the potential of the firm before you put in your hard-earned money into it.
These are some of the best investment instruments available to you. Choose the option that appeals to you the most and get the best returns out of your investments.
Insurance is often mistaken as a financial instrument. However, insurance is a very important product which needs to be taken but for the purpose of protection only and not as an investment.
What is a financial risk profile?
You may have heard the term “risk” quite often when you discuss your financial matters with others. But what exactly is risk and how does it affect your investments? Well, there is a very strong correlation between risk and investments. Most of the financial instruments used for investments carry certain degrees of risk. Simultaneously, every investor has a risk profile of his own. A risk profile is the amount of risk an individual investor is willing to take.
The risk profile of a person majorly depends on the three following factors:
1. Willingness to take a risk – Risk Tolerance. This is a psychological factor.
The first and the most important factor associated with risk-taking is the willingness to do so. You cannot possibly have a high risk-appetite if you are not willing to take a risk with your investments. Many people are conservative investors who do not like taking any kind of risk with the investments they make with their hard-earned money.
On the other hand, some investors believe in taking risks as they feel the more risks they take, the higher their chances get of making greater profits. This is a personal trait and differs from person to person. There is no fixed level or degree against which the risk-taking willingness of an investor can be measured.
2. Ability to take a risk – Risk Capacity. This is a financial factor.
The other factor that plays an important role here is the investor’s ability to take a risk when choosing the financial instruments. Not everyone is financially stable enough to risk all their money. If an investor has limited resources and banks heavily on the returns for his financial requirements, he cannot possibly afford to take a huge risk. In that case, he will have to settle for low-risk investment instruments. This is a factor that needs to be calculated before any investment is made. If in a worst-case-scenario, the investor loses his entire corpus, how would he cope with the situation? Once an answer is found to this question, the risk-taking ability can be clearly understood.
3. Need to take risk – Risk Requirement. This is also a financial factor.
You may not want to take too much of risk but in order to fulfill your financial goals, you might be required to do so. This is a pure financial planning oriented informed decision.
While the risk-taking willingness, as well as the risk-taking ability, need to be kept in mind, as an investor you have to take a few risks when investing your money. You surely do not invest for fun, do you? All your investments are done keeping your financial goals in mind. You need your wealth to grow so that you can have enough funds to meet your life-goals. So to achieve these, you need to take risks. If you invest all your money in fixed deposits, you will earn a much lower yield, as compared to the yield you can earn when you invest in stocks and equities. Of course, the risk will be lower in a fixed deposit, but will the investment be really fruitful for you? This is where the concept of risk requirement proves to be crucial and extremely important for serious investors who look to build up their wealth.
The risk profile of an investor is thus very crucial and determines the kind of returns he earns from his investments.
The key is to find a balance between the types of investment instruments. Rather than fixing all your money in a single financial instrument, spread it out and have a diverse portfolio. You should have a balance between the risky investments and the safe investments. This will help you to earn steady returns, irrespective of the market conditions.
How to choose the right financial instruments to invest based on your life stage and risk appetite?
Keeping all the points mentioned above in mind, you can understand the importance of choosing the best financial instrument to invest your hard-earned money. But how exactly does one choose the right and most suitable investment option? Here are some pointers:
Step#1: List down your financial goals
The financial goals determine your need to invest. Every individual has separate financial goals related to their life-situations. You need to first understand why you are investing. Are you investing to meet a short-term goal like clearing your outstanding student loan? Or are you investing to create a retirement fund? The choice of financial instruments will greatly depend on this as you need to find instruments that will drive in returns at a pace that suits you.
Here’s a complete guide to financial planning
Step#2: Make a true analysis of your risk profile
You need to be completely honest when assessing your own risk-profile. As mentioned above, the risk profile consists of two components – willingness and ability. Analyse both these factors about yourself and see just how much risk you can take with your investments. This is another way in which you can find the most suitable financial instrument to invest in.
Step#3: Factor in your age and dependents and financial liability
A young person has fewer financial responsibilities and has a higher disposable income. An older person may have a family to support, loans to clear off and an upcoming retirement to save for. This is why the investment patterns of people change as they age. A young person can definitely take higher risks with his money. However, he may not have a corpus as high as an older person who has been working for decades. Age is a crucial factor and your investments will majorly depend on your age. Choose an investment option that matches your age and life situation as this will bring in the best yields for you. Then you need to factor in your dependents and your existing financial liability.
Step#4: Understand the financial instrument
Each instrument has some pros and cons. You need to know the investment objective, the time horizon and then make an informed decision.
An extremely vital tip for you is to understand the financial instrument before investing. You cannot make the proper and correct choice unless you understand how the different financial instruments work. You should never follow someone’s footsteps and invest in a particular instrument unless you know how it works. For instance, if your brother makes money by investing in mutual funds, the same model may not work for you. You cannot invest your money in a mutual fund and expect to get the same returns unless you know what the procedure to earn the best returns are.
Step#5: Take the help of an expert
If you are in any doubt regarding the various financial instruments, you should take the help of a financial expert. an expert can guide you and help you to make the correct choices. Discuss your financial goals, risk profile and financial health with the expert and he will make the best plan for your investments.
Once you take care of the above-stated pointers, you will be assured of finding the most suitable financial instrument to invest in.
In a nutshell
The financial world is vast and as an investor, you find many good options to invest your money in. However, in the financial world, there is no instrument that offers the one-size-fits-all benefit. Every investor is different and has a different risk profile and financial capability. This is why you need to understand your own profile and capacities and choose the best investment instruments for yourself. Keep all the tips and guidelines mentioned above and choose your options very carefully, always try to maintain a mix and have a diverse portfolio. Along with this, keep your eyes firmly on your financial life goals and you will surely find the best instrument to invest your hard-earned money in.