Do you have a clear idea of what you want to achieve financially in life? Whether it is saving for your child’s education, buying a house, traveling the world, or retiring comfortably, you need to have a plan to reach your financial goals. And that plan involves choosing the right investment instrument for your money.
What is an Investment Instrument?
An investment instrument refers to a financial arrangement that offers the holder or beneficiary the potential to generate a return on their investment. There are many types of investment instruments available in India, such as cash, bonds, stocks, mutual funds, exchange-traded funds (ETFs), commodities, real estate, and derivatives. Each of these instruments has different characteristics, risks, and returns.
How to Set Financial Goals?
Before you can choose the best investment instrument for your money, you need to set clear and realistic financial goals. Financial goals are objectives that you set for yourself to attain certain monetary milestones or plans. They help you stay focused and motivated on your financial journey.
To set effective financial goals, you can use the SMART criteria:
- Specific: Your goal should be clear and well-defined. As an alternative to “I want to save money,” one could say “I want to save 10 lakh rupees in one year.”
- Measurable: You should be able to count and keep track of your goal. For example, instead of saying “I want to save more”, say “I want to save 10% of my income every month”.
- Attainable: Your objective should be both realistic and attainable. Instead of saying “I want to save 1 crore in a year,” say “I want to save 50 lakh in a year.”
- Relevant: Your goal should be aligned with your values and priorities. For example, Instead of “I want to save money for a premium phone,” say “I want to save money for a premium phone that meets my needs and preferences.”
- Time-bound: A time limit or target date should be included in your objective. Say something like, “I want to save enough money to retire by age 65,” rather than just “I want to save money for retirement.”
How to Choose the Right Investment Instrument for Your Financial Goals?
Once you have set your financial goals, you need to choose the best investment instrument that matches your goals. The investing approach will change depending on how long you can keep your money invested. However, the majority of goals fall into short-term or long-term categories.
Short-Term Financial Goals
Short-term financial goals are those that you want to achieve within one year or less. Examples of short-term goals are creating a budget, building an emergency fund, paying off credit card debt, or saving for a vacation.
For short-term goals, you need an investment instrument that is liquid, safe, and stable. Liquidity means that you can easily access your money when you need it. Safety means that you have a low risk of losing your principal amount. Stability means that your returns are predictable and consistent.
Some of the best investment instruments for short-term goals are:
- Cash: Cash is the most liquid and safe investment instrument. You can keep it in a savings account, a checking account, or a money market account. However, cash also has the lowest returns among all investment instruments. You may earn some interest from your bank account, but it may not be enough to beat inflation.
- Liquid Funds: Liquid funds are a type of mutual fund that invests in debt instruments with a maturity of up to 91 days, such as treasury bills, commercial papers, certificates of deposit, and corporate bonds. They offer high liquidity, low risk, and moderate returns compared to other short-term investment options. You can redeem your units at any time without any exit load or penalty. The returns from liquid funds are taxed as per your income tax slab rate if you hold them for less than three years. If you hold them for more than three years, you can avail indexation benefit and pay 20% tax on the long-term capital gains. Some examples of liquid funds are Quant Liquid Direct Fund, Aditya Birla Sun Life Liquid Fund, and Navi Liquid Fund.
- Recurring Deposits: Recurring deposits are a type of bank deposit where you deposit a fixed amount of money every month for a predetermined period of time, usually from six months to 10 years. You earn a fixed interest rate on your deposits until maturity. Recurring deposits are safe and stable investments because they are insured by the Deposit Insurance and Credit Guarantee Corporation (DICGC) up to ₹5 lakh per depositor per institution. However, recurring deposits are not very liquid because you may face a penalty if you withdraw your money before maturity. The interest income from recurring deposits is fully taxable as per your income tax slab rate.
- National Savings Certificate (NSC): NSC is a government-backed savings scheme that offers guaranteed returns and tax benefits. You can buy NSC certificates from any post office for a minimum amount of ₹100 and a maximum amount of ₹10 lakh. The certificates have a maturity period of five years and earn a fixed interest rate of 6.8% per annum compounded annually. The interest is reinvested every year and paid at maturity along with the principal amount. The interest income from NSC is taxable as per your income tax slab rate, but the principal amount is eligible for deduction under Section 80C up to ₹1.5 lakh.
Long-Term Financial Goals
Long-term financial goals are those that you want to achieve in more than one year. Examples of long-term goals are saving for your child’s education, buying a house, investing for retirement, or leaving a legacy.
For long-term goals, you need an investment instrument that is growth-oriented, diversified, and tax-efficient. Growth-oriented means that you have a high potential for earning higher returns over time. Diversified means that you have a mix of different types of investments that reduce your overall risk. Tax-efficient means that you minimize the taxes that you pay on your investment income and gains.
Some of the best investment instruments for long-term goals are:
- Stocks: Stocks are shares of ownership in a company. You can buy and sell stocks on the stock market. Stocks are growth-oriented investments because they can increase in value over time as the company grows and profits. However, stocks are also risky and volatile investments because they can fluctuate in price due to market conditions, company performance, and investor sentiment.
- Bonds: Bonds are loans that you make to a government or a corporation. You receive regular interest payments and the principal amount at maturity. Bonds are diversified investments because they have different maturities, interest rates, and credit ratings. However, bonds are also subject to interest rate risk, inflation risk, and default risk.
- Exchange-Traded Funds (ETFs): ETFs are similar to mutual funds, but they trade on the stock market like stocks. You can buy and sell ETFs throughout the day at their market price. ETFs are diversified investments because they track an index, a sector, a commodity, or a theme. However, ETFs also have trading costs and tracking errors that can affect your returns.
- Real Estate: Real estate is property that you own or rent out. You can buy and sell real estate directly or through real estate investment trusts (REITs). Real estate is a growth-oriented investment because it can appreciate in value over time and generate rental income. However, real estate is also an illiquid, costly, and risky investment because it requires maintenance, taxes, insurance, and management.
Conclusion
Choosing the right investment instrument for your financial goals is not a one-size-fits-all solution. It depends on your personal situation, preferences, risk tolerance, and time horizon. The best way to choose the right investment instrument is to do your research, compare your options, and consult a financial planner if needed. You need to be patient, disciplined, and flexible to achieve your financial goals.