Figure out your life before you figure out your investments

I am regularly asked - "Should I invest in equity now?"

There is no straightforward response to this question. Many factors have to be considered - the chief being - Do you know where you want to go? When do you have to reach there? Do you know where you are? Are these well-defined. Once you have a goal - a clear well defined goal, you will yourself have a hint on how to get there - i.e where you should invest. 

Three factors to consider while investing for your goals are Risk, Return and Liquidity

1. Risk: The chance that an investment's actual return will be different from what is expected. It also includes the possibility that you will lose a part of your capital / investment. For example, if you invest in equity shares today and need the money for your daughter's wedding next year, it is silly to invest in stocks today hoping to make a gain!!   The risk of loss is high. The return is not known to you. This is risk.

2. Return: This refers to the gain (or loss) from an investment. An investment is made for returns / gains and we only invest to get returns. However, a point to be noted that the higher the risk, the higher the potential for returns. For example, bank deposits are relatively risk-free. We know that currently we will get a return of about 9% p.a . The returns from stocks is unknown. There is risk, but gains can be high. The stock markets have already given > 25% returns this year!! Gold gave great returns from 2009 - 2013.

3. Liquidity: This is the ability to convert an asset into cash quickly i.e in simple language, the ease of selling of the investment/ asset to get cash. If you have to invest money now for paying your kid's college fees in about 3 -4 years, you would not invest in real estate. It is not easy to dispose off for cash. Whereas, bank deposits, mutual funds can easily and without much cost be liquidated.

Everything you invest in is going to require a sacrifice in one of these areas. If you want high liquidity and low risk, you’re going to have a low return. You’re probably going to be putting your money into something like a fixed deposit. An investment in real estate / property means lower liquidity, but could mean higher risk and returns. If you want high liquidity and high return, you’re going to have to take on some significant risk. You’re probably going to be putting your money into something like stocks and equity mutual funds.

There are different life situations that call for different investment options. So it basically depends on your goals in which your investment time horizon is intrinsic. The longer the time horizon, the more risk you can take and even sacrifice liquidity.

Equity mutual funds / Stocks have given a great return when the investment horizon has been for periods over ten years! For many people, it makes sense to invest in equity funds / stocks for the ease of rebalancing and selling them off in case they should need the money. (more on rebalancing investments later)

Remember that it is your goals and your life that is the key. The situation that you are in and what you need out of the investment will decide where you must invest - a bank deposit or gold or equity.

Without a plan, a goal for yourself, you will only invest at random, or worse still be carried away by advertisements, that neighborhood uncle who sells 'great' policies and will be stuck in illiquid, sub-optimal investments or worse still, face a severe loss.

Figure out your life before you figure out your investments. Know your goals first. The right investment becomes clearer.