There are several areas where you can invest your money. Our choices depend on our Objectives and Orientation.
Stocks
Historically, stocks indices have provided the highest returns over long period of time compared to other asset classes. The same cannot be generalized about individual stocks as they are more volatile compared to the broader index.
A lot depend on the timing of our investments and price of the stock when we buy it. Which stock to pick and what analysis needs to be done to decide will be governed by various factors and there are several websites and books that can brainwash you. I do not intend to cover more on this topic here.
Mutual Funds & Exchange Traded Funds (ETF)
We can consider Mutual Funds as a professionally managed investment fund that pools money from many investors. They are a common portfolio traded in the markets (like ETF) or be bought and purchased through the Mutual Fund company. Each mutual fund publishes Net Asset Value (NAV) every day. This is the value where we can buy or sell units of mutual funds.
Usually, they have an entry and exit loads which are expressed in %. So, if you wish to purchase a Mutual Fund, then you would have to pay NAV plus the Entry Load and if you are selling it you will be compensated NAV minus the Exit Load. The fund houses, at their discretion, may change these loads from time to time. However, if they increase these loads significantly, they will become unpopular and their portfolio (a.k.a. Asset Under Management or AUM) would reduce as a result. Though it is not a rule, it should be noted that for funds that are specialized and need active participation of the fund managers carry higher loads compared to less specialized ones.
One of the biggest advantages that Mutual Funds provide over other Investment Avenues is that you do not need to be actively track the markets. The Fund Managers will do that job on your behalf. You will need to review your allocation on a quarterly or a semi-annual basis.
The other key advantage is that you can schedule systematic investments to purchase Mutual Fund units at regular intervals (can be daily, weekly, monthly, quarterly or annual). You can similarly setup systematic withdrawals from Mutual Funds. This is a massive advantage when it comes to de-risking your returns. In the later section Importance of Regular Investments we will examine how Systematic Investments and Withdrawals can help with de-risking.
Gold (and other precious metals and gems)
Gold has traditionally provided positive returns over longer time periods. However, they are not as high as stock indices. The usual trend and mass mentality is that one will buy Gold when there is higher uncertainty and sell Gold when other investment avenues are performing well. There are certain sections of customers, however, that would buy Gold and add this to their Long-Term Portfolio.
When we think about buying Gold there are 3 options – buying Gold Jewelry, Gold biscuits, or Gold funds. The first 2 require you to incur custody charges. There is usually a making charges for Gold Jewelry. From investment purposes, it is best to invest in Gold Bonds/ funds rather than actual physical Gold.
The greatest benefit that Gold provides is that it can be used as an excellent asset for de-risking (a.k.a. hedging) your investments. Remember – when economic outlook is unstable, people buy Gold.
Insurance as an Investment
There are several other avenues where you can invest but the least known is using certain life insurance products available in the market today to invest and create a medium term to long term asset. Yes, you read it right – this is one additional avenue that you can use. Here is how…
Traditionally Life Insurance was offered as a protection against an eventuality which is Death of the insured. The insured paid premiums throughout the period of the contract and in turn the insurance company insured the individual for a certain amount. These policies usually lasted for time periods ranging from 5 years to 35 years from the time they were issued. It did not make any sense to purchase a 30-year term life insurance for a 20-year-old as the probability of the insured surviving (based on life expectancy) was very high. This meant that the insured would pay regular premiums till he is 50 years old and if he dies one day after his 50th birthday, the insurance company will not be liable to pay any compensation. So, it made sense to buy such a policy for protection purposes when you are more than 40 years of age. This will at least increase the chances that your death benefit will be paid by the insurance company.
The industry has evolved since then and now offers products that charge higher premium but ensure that the beneficiary of the insured will get the death benefits paid. They assume that the insured will live up to an age of 100 years or 120 years.
Now this still does not make a case for using Insurance as an Investment. They further improvised their offering and added a “Cash Value” component to the mix in return for still higher premiums. What this does is that the insured can pay the higher premiums. A component of the premium goes towards “Life Protection” and the balance left after deducting fees is invested in either a fund that can provide variable non-guaranteed returns over the years or in instruments that would give guaranteed fixed returns.
For non-guaranteed investments, insurance companies soon realized that they cannot gamble money on lives of individuals. If the market falls, then the entire cash value of the insured will be eroded. So, they came up with a way to protect the investments. They provided a floor interest rate. If the underlying security that is used to compute the increase in your cash value provided a -15% return during a given period, the insurance company will still honor a floor of 0%. This ensures that your cash value does not erode. To counter this benefit that they offered to the insured investor, they added a cap value to the returns. If the underlying security provided a +20% return in a year and your returns were capped at 12.5% then your cash value component will grow by 12.5% during that period.
These measures ensure that the insured’s cash value component will grow irrespective of market downfall. This still does not explain how we can use this amount as a medium term to short term investment.
This leads to a final improvisation that will enable the investor to realize this dream – you can withdraw monies from your cash value! The insurance company would charge between 0% and 1% interest on the withdrawn amount. The withdrawal will be treated as a loan (so it becomes non-taxable). You do not need to repay the loan at any time after you withdraw. The cash value will be reduced by the amount of withdrawal and the residual amount will continue growing. There is no impact to the insurance component, so protection remains intact.
The dual benefit of insurance and investment comes at higher management fees and costs. So, your returns will be tamed. The biggest advantage, though, that this approach will have over the other 3 asset classes we discussed is that the money will not reduce. It starts working for you and attracting more money so long as you stay invested.
