Investment Basics & Capital Market
(by MS. KG Lakshmi, PG Student, IIPM, Mumbai)

Module: 1 - Investment Basics - Page: 1 of 2

[Module Objective: This module seeks to bring out in simple terms all about the efforts of scattered individuals all through the country to save, invest and provide large capital to business and industry; How investment drives growth of our savings; And the basics of portfolio investment]

We earn money to meet all our demands. But from our present earnings we are eager to set aside a small part towards our future use, keeping in tune the old adage "save for the rainy day". We are motivated to sacrifice present options and preserve a part of our purchasing power to conserve it to be available for future application. We know that this sacrifice diligently accepted today yields added benefits in the future. This is because we all know that money is not merely a medium, a measure, and a standard, but also a store. Thus we create our savings i.e. value kept in store and retained with us, a prized possession and a life cover providing extended security. Savings thus accrue out of deferred consumption or unspent receivables or in other words a present forfeiture made for a future benefit. As we save regularly the need arises to ensure safe-custody of our savings i.e. to park them secure, to be readily available to us whenever opted by us. We therefore choose to entrust our savings with an investment institution. When money is retained by postponing part of the present expenses, it is saving. When it is entrusted (deposited on the basis of a contract) with a financial or commercial agency it is investment The decision to choose the particular investment agency and further to select a particular investment product it offers for holding such savings is termed as an investment decision. A wise investor when making the investment decision will keep in his consideration three principal objectives as under:

Whether the money entrusted for investment will remain safe and secure? (Security consideration)

Whether the investor will be able to get back his savings whenever demanded by him. In other words whether there would be a quick and easy exit route from the investment deal. (Liquidity consideration)?

Whether he would gain and earn sufficiently out of his investment. (Consideration of quantum of profitability or reward)?

We also know that money preserved or deposited with a financial institution appreciates over time, denoted by the concept 'Time Value of Money'. As per this concept wise management of our savings results in progressive value addition at the future intervals of time. Conversely it is equally possible to access future cash receivables at a discounted rate at the immediate present. Thus while most other physical assets have the tendency to depreciate in value if stored over time (implying a holding cost), money has the unique quality to appreciate, if prudently invested (implying the holding benefit). Investment is storing/depositing money with a financial institution prudently effected by the investor to provide for an optimum appreciation of its value while being held as investment. The financial institution in turn productively deploys the money entrusted with it. Thus investment of money is different from simple hoarding thereof, where it remains idle and in an inflationary economy will actually be losing a part of its purchasing power. Money lending is not investment. Investment is made in approved securities or with banking institutions or with other financial intermediaries like Mutual Funds or Insurance Companies. All such institutions are supervised by market regulators, like RBI, SEBI and IRDA to protect the interests of investors.

The element of risk in investment surfaces when the components of security or liquidity fail or there occurs erosion in the quantum of reward or profitability contrary to what was anticipated. The financial institution or corporate organisation where our money is invested may deteriorate in its financial status and become near bankrupt. Else its business progress may be retarded resulting in its inability to pay back our invested funds in time or as originally contracted. There may be a steep erosion in the market in the rate of interest offered when investment was earlier made under floating rate scheme, or fall in the value of securities or rate of dividends declared thereon. Thus when the investor tempted to choose products yielding higher return, he must verify if this is actually offered to lure him to invest his money as a bait because of inherent or invisible weakness in the financial position of the Institution accepting our savings, exposing risks in terms of security or liquidity. On the other hand total reliance exclusively on security and ready availability of exit options to get back our invested savings may yield only poor return. Money deposited in a Bank in Current Account is safe and totally liquid, but it yields no return. A fixed deposit invested with a public limited company, or NBFC may fetch a higher return, but may expose risks of becoming insecure or illiquid. Decisions in respect of personal investments or that of investing funds of institutions have therefore to be pragmatically made, in terms of choice of the financial institution with which investment is placed and in making the option for particular products, as per the objectives or aims of investment we choose to make.

It is significant to mention that savings in India or elsewhere are largely gathered or mobilised from individuals and families. Corporates and Institutions generate very little savings. In India annual savings of the country are around 23% of our GDP. Of this as much as 19% is contributed by individual and families. Financial institutions and bodies like pension or provident funds initially mobilises huge savings from individuals and later invest such pooled savings in securities. The Asian Development Bank, for examples, raises low cost capital by selling its bonds at the European and American Financial Markets at the prevailing market rate of 2 to 3% and invests part of its unutilized funds in the Indian Securities market to earn 8 to 12 percent return thereon. Thus we will find a number of financial institutions like banks, insurance companies and mutual funds ever active in security operations in the stock exchanges. As part of the process of financial market liberalisation RBI and SEIB have approved registered foreign investors to operate in Indian Stocks exchanges without any restrictions. Non Resident Indians (NRI), Persons of Indian Origin (PIOs) and Overseas Corporate Bodies owned largely by Indians (OCBs) are also allowed to invest in our securities market. Thus while individuals are the main savers and providers of inputs to the capital market they are not the major buyers or sellers of securities in the primary & secondary markets segments. Institutional Investors endowed with very large indirect funds that are gathered from individuals, happen to the major participants in this market.

Investment therefore implies prudent choice and alert monitoring. This is Investment Management. Savings accumulated through sacrifice by foregoing current consumption, loses value and purpose unless invested prudently. Investment is a means to secure not only safe custody and quick retrieval (liquidity) of our money saved when needed but also to fetch added return by way of interest, dividends etc. Judicious management of diversified investment spread over different outlets (securities) when effected is called portfolio investment. It represents investing in and regularly monitoring and managing a basket of securities. Earning money is through sustained effort and arduous exertions. Saving money involves forbearance and sacrifice. But it is more important and more difficult to make wise investment of the hard earned savings in safe and profitable outlets. Earning money and saving a part thereof lose substance and purpose, if the money is not invested prudently. This explicitly brings out the importance of a meticulous understanding and application skill in dealing in the volatile financial market. This market at once favours you a golden opportunity to reap a treasure or an imminent threat to lose your entire savings & even more. This skill and expertise is implicitly needed in portfolio investment and its management. Portfolio management consists of profitable investment plus judicious risk management. In simple terms it means diversification of investment of larger sums of money by way of a prudent mix of securities as part of risk reduction followed by close monitoring of market movement. An individual in the middle income group at his own level through expertise gathered can effect portfolio investment ranging between Rs.5 to Rs.10 Lakhs. But for larger amounts it is advisable to seek guidance from a specialist portfolio manager. Corporate investments ranging to several crores of rupees are made by a team of professional specialists, termed as providers of portfolio management service (PMS). These business firms have in-house research departments to analyse and wisely foresee and forecast market tendencies. Here it turns to be investment plus professional management.

For example an investor in the middle level category chooses to invest Rs.5,00,000/- in a safe but remunerative mix of securities. He invests Rs.50,000 in a bank fixed deposit for three years; Rs.1,00,000/- in two different Mutual Funds partly in income funds and partly in open ended growth fund (with assured exit option). He also purchases post office Monthly Income Scheme for Rs.50,000/-. All monthly incomes or those received at other intervals from these investments are collected in his savings account with a bank and through this source he purchase a life insurance cover for Rs.10 Lakhs. He still has Rs.3,00,000/-. Of this he invests Rs.2.0 Lacs in debt securities distributed in three different companies/institutions and the remaining Rs.1.0 Lac he invests in equity shares spread over Scrips of reputed corporates in three different categories of industries. He has now gathered a basket of securities or portfolio of securities. Periodically he reviews the current yield and market status of each of his investment and makes suitable changes, whenever required. This in short is a portfolio management.

Should the rate of interest offered by the bank, which is presently at 6% per annum were to increase to 8% or more in the subsequent period, the investment in this category will be increased by him against corresponding reduction in some other category providing a lower rate like the debt-fund securities. If the investor foresees a future trend of bearish outlook in the stock market, he may choose to dispose of his equity stocks when the market is still bullish and repurchase the same at the lower price when it actually turns bearish. Sagacious management of the securities suited to the particular developments in the market is the essence of PMS. Initial selection of securities and parking of the funds therein covers only halfway in the path. The first task is the initial investment, but the final results depend more on its prudent management. It is at once discreet investment accompanied by its intelligent management.