With increasing information availability, the task to evaluate investment options is becoming challenging. In this post, I am noting the key principles I follow while shortlisting an investment option to suit my needs.
Let me start this post with a small story which many of my readers may relate to in their journey of identifying suitable investment options. An insurance agent approaches an investor with a new investment option. The initial investment returns look attractive. He explains like this > It is a 10-10-20 product. You need to pay 10 installments of 100K each for 10 years. Post that you will get need to wait for 10 years for your investment to ripen up. Now comes the reward time for next 10 years, i.e. for next 10 years you will get an amount equal to your yearly insurance premiums. And the finally, the icing on the came > you will get 20 times of your annual premium, i.e. 20 lakhs (2 million) on the maturity date after 30th year.
The outcome in a summary is in the image below. One needs to pay 10 lakhs for 10 years, need to wait for next 10 years, gets back the entire 10 lakhs and finally gets another 20 lakhs in the end. So you invest 10 lakhs and get back 30 lakhs.
This sounds like an awesome investment proposition to many of his gullible clients who do not go into the details and become a bait. After a few years of paying in 100K, they realize the following :
- If they intend to break the payment schedule during the first 10 years, there were heavy penalities;
- If they want to withdraw their money prior to the maturity, they would get a fraction of what they had invested.
- There are heavy transaction charges which were hidden from them or atleast they didn’t look into;
- Despite of being locked into for 30 years, their yield (return) on their investments is a meager sub 5%. They could have earned much better returns by putting the same amount in a Fixed Deposit with a bank, forget about 2-3 times of that figure in other growth options.
There are many such stories out there. Many of my readers may be impacted personally or would know someone who got impacted by similar schemes. From here onwards, I am sharing a few of my investment principles which I follow for evaluating investment options and financial decision. This has helped me many times to avoid dangerous pit falls which aren’t always initially apparent.
Transparency
An investment product must be transparent and fully disclose
- Where it invests my money now, i.e. the current detailed portfolio. I may not read it always, but I would like that transparency.
- Where it can invest my money in the future – this will give me clarity on the risks it may take in future.
- Answers to the questions which may need me to assess the other investment principles, i.e. flexibility of entry / exit, fees & charges, growth possibility in the future
The outcome may end up being data heavy, but that is fine for me. I would rather want more information here than less.
Flexibility
This is my next most important check. I do not prefer products which take my freedom of how I would like to deal with my money. If any product aims to bond me beyond a normal period of time (generally beyond 3 years), I start getting extremely uncomfortable. Let me clarify, I consider myself as a disciplined investor. In many cases my investment horizon goes beyond a decade or two. But I do not want a product to enforce discipline onto me. An investment product must give me following key flexibilities :
- Beyond the minimum regulatory thresholds, ability to invest as much or as little as I want;
- Ability to stop incremental investments, reduce them or increase them with no penal implications;
- Ability to withdraw my entire or smaller chunks of my investment proceeds with no penal charges. I am fine with reasonable restrictions of upto a couple of years to align with the investment strategy of the product. But going beyond 5+ years is a difficult call for me to get aligned to.
Cost
The amount of wealth generated by an investor is a simple mathematics of Growth in the value of the investments less expenses paid to achieve the growth.
At the outset, good things seldom come free. But paying through the nose may not be a good idea as well. Cost is a relative term when it comes to investments. An investor must do a basic due diligence around the costs being paid for a specific investment option versus other alternatives available in the market. Some of the onerous cost structures in an investment option include unreasonable distribution / brokerage costs paid to distributors / advisors / agents, fees upon the performance of high growth investments, etc. While doing so, I would also like to caution investors not to overdo it. I have seen so many cases where too much focus on cost may end up outscoping a good wealth generating product. A reasonable balance is a key consideration here.
Growth Orientation
I have different life objectives which have different time lines, ranging from a few years to 10+ years. Each of these timelines give me a fair idea of the type of investment option I should choose to help me achieve my objective. I also do an allocation of investments across different asset classes and geographies to help me better manage the investment risks. This is all good till here.
If my life goals for my investments are beyond 5-10 years away, I may consider it being invested in Growth oriented assets like Equities instead of wealth protection assets like Debt. This is where understanding the type of asset is key. I often see people holding conservative debt and insurance portfolios and keep on investing into them for decades. These would at max preserve one’s wealth. It is also likely that the inflation may grow faster than the returns from such portfolios, eventually resulting in a worse off financial situation.
My Growth Orientation check aims at aligning the right investment option with the timelines for which I want to invest for. For example, if I need to go to a place across the road, I may choose to walk. But if I need to go from a city to another, it would not be a best decision to walk. Similar is the thought process for investments.
Simplicity
Simple is good, especially when it comes to money matters. I start giving negative points to an investment option which takes more than a reasonable amount of time to understand. This could be true for a vast majority of investment options. It should not take multiple pages to explain the features of an investment.
I do acknowledge that there would be a specific set of complex investments which may be engineered for specific needs. These are outliers and in many cases will be out of the reach of majority of the investors.
Tax Efficient
The Income Tax Act of India is prescriptive on how it will tax different investment options. I have n o issues in sticking with an investment with its inherent taxation as long as it is a thought through part of my investment allocation.
However while assessing any investment option I would like to assess if it is being a tax efficient option compared to other options available in the market. For example, while investing in Gold, I can do it via physical Gold, Gold ETF or Sovereign Gold Bond (SGB). The first two are taxable but SGB is tax free if held till maturity. Similarly, while Equity investments held through a Mutual Fund structure may not attract ongoing Short Term Capital Gain taxes for the churns done by the fund manager. Same asset class under a PMS or Direct Equity investment may attract taxation for any changes in the portfolio. A good understanding of tax laws of India and your respective home jurisdictions (in case of NRIs) is necessary for this check.
I would like to end with a thought to consider. One spends days researching for a mobile phone, its features and reviews. If for a depreciating asset so much of time is being allocated, why not to allocate a fair share to evaluate investment options which will go a long way to help you reach your life goals.
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