I had done this post on Moneycontrol long back…
Immaterial of whether you are in your 20′s or in your 50′s – and want to explain it to your children – or you are looking at an investment you should know some of the basics of investing, so here it is.

What is an investment, shorn of all its jargon?

It is a sum of money that you outlay hoping to get a higher amount back. This can take two forms:

1. Investment like a lender                                            2. Investment like an owner

Investment like a lender means you are giving your money to an organisation for them to use so that they can grow their business. As a compensation for using the money, they pay you interest. If you invest in PPF, NSC, Kisan vikas patra, RBI bonds, etc. you are lending money to the government of India. However, if you keep money in a fixed deposit in, say HDFC, you are lending to a private sector body. Bank deposits also fall in the category of `investing like a lender.` What are the advantages and shortcomings of such an investment?

– Certainty of interest, when it will be paid and when the capital will come back
– Convenient to handle
– Simple to understand ? the only thing you need to know is the amount of interest, and will the original amount that you put in comeback.

Shortcomings:

– Inflation may erode the amount, substantially. For e.g. if the inflation rate is 6%, the value falls by 44% in 10 years time. So if you get the SAME amount (back) that you put 10 years ago, inflation has eroded its value.

` Default risk ` the person taking the money does not repay. Many co-operative banks, some nbfcs, some small business owners, may fall in this category.

` Delay risk ` if the government of India decides to postpone your PPF payment by 10 years what will you do? Looks odd, but remember some politicians may decide that all amounts above Rs 0.5 milllion should be paid in installments you may have to grin and bear it.

– You take the risk, but if the company does well your rewards do not increase.

– Debt is not risky in the short run, but it is risky in the LONG RUN.

2a. To invest like an owner means you are joining a company as its partner. This obviously means you get a portion of the company, you get the accounts of the company, they report to you on a quarterly basis, they allow you to participate in the well being of the company, ….all the perks of ownership.Advantages:

1. You get to participate in the well being and in the ill being of the company.
2. When the company does well, you get a fantastic hedge against inflation
3. You get dividends and price appreciation as rewards for holding shares

Shortcomings:

– Stock picking is not just watching TV and buying the `hottest stocks.` It takes a lot of effort to pick a good stock, to structure a portfolio and keep allocating resources to the correct companies.

– It is very risky in the short run
– You require a good head, and a greater stomach to make money with shares

2b. Not enough attention is paid by people to investment in real estate (I mean actual, active investing, not buying a house and hope it will appreciate). If you can keep buying properties, rent it out, sell when appropriate, real estate will also give you an excellent inflation adjusted return. The advantages are that in a worst case scenario, you can use the assets, however it requires a lot of expertise. Also individual real estate calls are complicated (Real estate mutual funds – we have been hearing about it for long, hope it happens fast). A very unstructured, unsupervised market. If you find a good advisor, you are blessed. My real estate portfolio is with a veteran who gives me stunning returns.

2c. Starting / Partnering a small business! Small business is big business. Most of the world economy is supported by the small business owner. Most of the jobs are created by them. Their media share is much less than the market share that the small guys have!

I hope I kept is simple. My wealth creation has some formulae. One of them is to do all four:

– Invest in a good portfolio (mutual fund or unit linked insurance with a small recurring charge)
– Select a good fund manager (I mean fund house)
– Do an SIP
– Think long term ? I mean 10+ years

If you do all four, I daresay you can look at Warren Buffet and say, “Sir I listened to your rule number 1. I have not made losses.“ That is great!