What Are the Different Types of Investments?
Most investments can be categorized as either equity investments or debt investments. In an equity investment, a person buys a share of the ownership in a company, which entitles the investor to the profits and losses of the business.
For example, if you buy a ‘Food Truck’, your profit will be based upon the net profit that the food truck generates. Similarly, if you buy shares of a company, your profit is based upon the rise (or fall) of the value of the company’s shares and the dividend which Reliance pays (if any).
Fixed Income or Debt Investments
In a debt investment, you lend money to a business or a government institution. However, in this case, your’s business. If you buy a bond you are eligible to receive a fixed interest irrespective of the profits earned by the firm or the government.
Besides above stated kinds of income (dividends in case of equities and interest in case of debt), one can also earn capital gains by sale of the investment. Due market factors the price of the equity and debt changes almost daily and the difference in the price of sale and purchase is investors’ capital gain.
Direct Investment Instruments
You can invest directly into the stocks of companies or buy the bonds issued by them and the government.
Stocks or Shares
Stocks are simple- they are shares of ownership in a specific company. For example, when you own a share of you own a tiny piece of that company. In general prices of stocks fluctuate with the company’s fortunes, and with the changing conditions of the economy at large.
Bonds are certificate of your lending money to the issuer at the said interest rate. The interest on each bond could be paid to you regularly and at the end the face value is returned. Alternatively, you can also sell the bond before expiry if you need.
Investors are attracted by this investment type because of its relative safety. However, you should always check the rating of the corporate bonds, to ascertain the risk involved.
Highest rated bonds and government securities often carry lower risk, but they will also offer lower rate of interest.
Indirect Investment instruments
Indirect instruments refer to the funds and instruments which invest in a variety of stocks or bonds or both on behalf of investors.
These investments are professionally managed and highly regulated. Following are some of the most popular indirect investments:
- Mutual Funds
- Unit Linked Insurance Plans
- Other Debt Investments
Although, there are various divisions within these investments, but the most useful is the risk-return possibility in the three categories.
Understanding the risk-return profile of the three investments will help you decide when to invest in which category of instrument. We discuss this in the later part of this page.
However, you should know that smart investors are always diversified into all three categories in various proportions, based on their own risk tolerance and financial needs. This too we shall discuss in detail later, but first let’s have a look at the instruments where you can invest under each category.
A mutual fund is formed when money is collected from different investors and invested in a company’s stocks or bonds. Typically, a mutual fund is shared by thousands of investors and is managed collectively to earn the highest possible returns. The person driving the mutual fund is a professional fund manager.
Mutual funds offer diversified investment with lower investment corpus, in any or multiple asset classes.For example, you can invest in a pure equity fund, a debt fund or a hybrid fund investing in both stocks and bonds.
Mutual funds may offer various risk category funds based on the type of stocks or bonds they are investing into. Index funds are considered the safest fund category among equity funds. Whereas, Gilt funds are the safest bet among the debt categories.
Unit Linked Insurance Plans (ULIPs)
ULIPs are Life insurance plans with an additional feature of investing your money in multiple assets based on your investment goals. However, there are two big differences: –
1) You can invest in multiple funds under a single ULIP investment – Equity or Debt or a mix of both.
2) Your family gets the assurance of life insurance that ensures that your financial goals are met
Thus, ULIPs are another route to invest in a professionally managed portfolio of equities or bonds. The benefit of investing in a bond fund through ULIP is that as per the prevailing tax laws, you may enjoy tax deduction under section 80C subject to fulfilling conditions therein.
ULIPs offer clear classification of risk categories, where you can pick up the higher risk fund for the long-term goals. You can gradually shift to lower risk investments as your investment nears maturity.
Other Debt Investments
Public Provident Fund (PPF) & Similar Investments
PPF is a saving scheme offered by the Indian Government, allowing investors to deposit funds for a fixed period and earn returns on their savings.
PFF investments are safe, easily accessible, simple to understand and tax-free, making them a popular investment avenue for most individuals.The interest rate offered by the Public Provident Fund is 8 percent, as applicable from 1st October 2018 (Source: Ministry of Finance).
Sukanya Sammriddhi Scheme is another debt investment, which is very similar to PPF, however can be only operated by parents of a girl child.
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