Download - Ifp 20 Fundamentals of Investment Planning

7/30/2019 Ifp 20 Fundamentals of Investment Planning

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Chapter 20


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What is Investment?

Investment refers to a commitment of funds to one or more assets that will be held over some futuretime period. It is important to understand the difference between savings and investments. Anythingnot consumed today and saved for future use can be considered as savings. Almost all of us save money. In

fact, we are a nation of savers where the domestic savings is a high percentage of Gross Domestic Product

sometimes as high as 26-27%. It is important to channel these savings into productive investment avenues.

Almost all individuals have wealth of some kind, ranging from the value of their services in the workplace to

tangible assets to monetary assets. For our purposes, investment will mean a measurable asset retained in

order to increase ones personal wealth. A financial asset is one that generates income and contributes toaccumulation and growth of wealth over a period of time. The two elements in investments are generation of

income on a periodic basis and/or growth in value over a period of time.

Investment Scenario in India

A pick-up in investment, reflecting the high business optimism, not only strengthened industrial performance

but also reinforced the growth outlook itself. The rally in Gross Domestic Capital formation (GDCF) that

had commenced in 2002-03 continued and as a proportion of GDP, it reached a high of 30.1 per cent in

2004-05. Stock market index returns of 11 per cent in 2004 followed by 36 per cent in 2005 provide a

good measure of investor sentiments. There have been ups and down in the cycle, however, the movement

and growth has been positive.

The increasing trend in gross domestic savings, which provided most of the resources for investment, as

a proportion of GDP observed since 2001-02 continued with the savings ratio rising from 26.5 per cent in

2002-03 to 28.9 per cent in 2003-04 and further to 29.1 per cent in 2004-05.

India, a nation of savers

India is a nation of savers and the domestic savings is a very high percentage of GDP. It is shocking to note

that more than 45% of domestic savings is invested in bank deposits and only about 2/3% in equity and

equity related investments. This clearly shows that while as a nation we are very good savers, we are very

poor investors because it is equally important for the savers to invest in avenues that fetch decent returns

after considering factors like inflation, taxation, etc. Bank deposits not only offer lower returns but they are

hardly tax efficient and thus do not serve the cause of earning high post tax and net of inflation returns. Indeveloped countries, the proportion of savings being diverted to equity and equity related instruments is in the

region of 20-25% of GDP while around 20% of savings are parked in bank deposits.

A Financial Planner

Some investors have failed to recognize that the less obvious, but potentially more damaging, is the risk

of diminished income staying completely invested in low yielding fixed income securities or bank

deposits.The financial planner should ensure that investors take a hard look at the fixed income components

of their portfolios and rethink this strategy in the context of a more comprehensive, long-term objective,

understanding where the clients come from, the priorities in their life and the challenges they face in a

Fundamentals of Investment Planning


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rapidly changing investment horizon. Succeeding in career, planning childrens education, marriages,

and having more than enough for an enjoyable retirement are some of the objectives most people aim at.

The financial planner in India, hence, has a very important role to play. The planners job in India is more

challenging because of the Indian mind set and the aversion to risk. It will be part of his job to educate his

clients on concepts of risks and returns and their relationship.

Investment Fundamentals

Some of the fundamental rules of investments are:

Start Early

Invest Regularly

Ensure Higher Returns on Your Investments

Let us study the effects of good investing principals through two examples.

1. Prem started investing money to the tune of Rs. 6000 pm diligently. He began this discipline at the age

of 21 years of age. He was earning a rate of interest of 12% compounded each year. While his friend,

Poonam started investing money to the tune of Rs. 10000 pm. She was also doing this very religiously.

She also earned 12% compounded. She started the process of doing the investments month on month,

after the age of 30. What are the total sums adding up to at the age of 50 years of age?

2. A second example of starting early to fulfill your dreams is shown below.

According to the College Board, college costs for the 20062007 school year are roughly Rs145,000

for four years at a private school and Rs.71,000 at a public school.

Two couples need to save Rs.150,000 for college expenses, but begin investing at different times.

Priti and Subodh begin investing the year their daughter is born, making monthly investments of

Rs.311 to reach their goal. Nirvan and Juhi start investing when their son is eight years old, making

monthly investment of Rs.815 to reach their goal.

Assume an 8% return per year compounded monthly and that the child enters college at age 18. This

example does not represent any specific investment

As you can see from the table the cost of waiting for Nirvan and Juhi its Rs.30,624. Priti and Subodh

benefited from eight more years of compounded growth than Nirvan and Juhi, which means Priti and

Subodh put in less money to reach their goal.


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