Investing is a often a long journey. To make the best out of it, one needs to follow the right process and have a clear sense of direction. There may be many ways in which one can follow the right approach (if there is any!) – And all of them can be correct.
However, as one embarks on this path it is important to ask the right questions and seek justified answers. (Which may or may not turn out to be correct, but at least there is a method and not madness in the approach.)
Here are 5 questions you should ask before investing
1. What is your purpose of investing?
Asking this question is the beginning of your investment journey. Any systematic approach to investment entails knowing your goals (e.g. kids’ education, marriage, financial independence, buying a house, a comfortable lifestyle post retirement etc.) and aligning your approach towards it. And this goal should be more than just “everyone is doing it” or “i have some spare cash”
(You may also be interested in – What is the purpose of investing?)
2. How does this investment work – and why will it give good returns?
It is not uncommon to hear people claiming equities giving “15 percent annual returns in long run”. Or people talking about doubling/ quadrupling their money in short span of time via cryptocurrencies (at least till the year before). Or people claiming that graphite or FMCG stocks (or any ABC stock) will double your money in few years. Or investing a house being a “sure-shot” money-doubler in 3 years …
Some or many of the above mentioned things may have happened/ may happen or may not have happened/ happen. However, while making a plunge in any kind of investment one must get some basic understanding of why that investment is expected to give returns, For instance, equities may give good returns due to growth in economy. Real estate may give good returns in some areas because of upcoming industries/ investments and so on.
So, before anyone recommends you that XYZ is a good investment, apply your own reasoning why that XYZ may be a good investment. You may want to be an investor in XYZ because you think that it has a sound rationale behind giving returns, and not because of greater fool theory. No?
3. What are the returns you are chasing (including costs & taxes)?
Are you chasing a high return, but are OK with associated risk and falling short?
Do you feel OK with less returns, but would not like to lose your initial capital?
You are OK with lock in period but want to save taxes by making use of tax-free provisions, like that in PF or PPF?
Are you effectively lowering your returns by getting into debt with hopes of better returns on investment? (e.g. taking personal loan for investing in equities)
4. What is the downside of your investment?
Risk and returns are correlated. Higher the expected returns, more is usually the expected risk. So, if you are putting all your savings in equity mutual funds, you may be risking under performance or even negative returns, But on the upside, returns can be huge. With a fixed returns instrument like PPF the risk can be unlikely possibility of government default or a likely possibility of under-performance vis a vis equity mutual funds.
So, when you are chasing lofty returns, be aware of the returns that may not come, and be OK with it, since you have already factored in that possibility, rather than be shocked with low returns, if they happen. As the old adage says – hope for the best, but be prepared for the worst.
5. Can you use it when in need?
Some investments are more liquid than others. You can withdraw a Fixed Deposit (FD) or liquid fund at a very short notice. You may even withdraw your equity investment at a very short notice. (But returns may be subject to market vagaries at that point of time). However, for real estate, the selling process may probably take few months. For instruments with lock-in period, like PPF or NSC or ELSS, you may have to wait for the lock-in period to get over.
If you happen to be in urgent need of money, will you be able to access it immediately?
If your investments don’t help you when you are in need (despite having good returns) they may not be good investments at all.
To sum up, start your investment journey by asking right questions and you may be on the right path. It may not guarantee you the highest of returns, but you’ll be aware of what to expect (and what not to expect). And more importantly, it will help align your investments to your financial goals.