Investment Landscape — saving, asset classes, needs and goals

Where this chapter sits

Chapter 1 carries 6% of the paper. It is the conceptual foundation for everything that follows — no formulas beyond a compounding calculation, and a handful of lists.

The single most examinable thing here is the inflation formula, and the second is which asset class does what.

1.1 Saving or investing?

Do the two words "saving" and "investment" mean the same thing? The workbook says they do not, and the distinction runs through the whole chapter.

The word "saving" originates from the same root as "safe". The safety of money is of critical importance here. Whereas, when one invests money, the primary objective typically is to earn profits.

And a warning attaches immediately: the important point to note here is that there is a trade-off between risk and return.

The second difference: the dictionary definition of "saving" – reduction in the amount of money used. This definition refers to reducing consumption so that some money is saved. It is this saved money that can be invested.

But they are not opposites — they are sequential. Saving and investing are not to be considered as two completely different things, but two steps of the same process in order to invest money, one needs to save first. Thus, saving precedes investing.

Save first, then invest. You cannot do the second without the first.

1.1.1 The seven factors for evaluating an investment

The three most important factors to evaluate investments are safety, liquidity, and returns. In addition to these, there are few more parameters such as convenience, ticket size (or the minimum investment required), taxability of earnings, tax deduction, etc.

Three primary, four secondary. Learn the split.

Safety. This begins with the safety of capital invested. However, one could stretch that to also include the degree of surety of income from investment. In order to understand the safety of an investment, it is important to understand the risks involved.

Liquidity. How easily can one liquidate the investment and convert it to cash, at fair value?

The obstacles vary: sometimes, the nature of the product could be such that selling it is difficult, whereas sometimes there could be some operational features, e.g. a lock-in for a certain period, after which one may be able to liquidate the investment; or a penalty for early exit.

And a careful distinction on exit penalties: while such a penalty does not hamper liquidity, it only lowers the investment returns. A penalty does not stop you selling — it makes selling costly, which is a returns problem rather than a liquidity problem.

Plus one more question: another aspect that one may also want to look at is the divisibility. Is it possible to liquidate part of the investment or is it necessary to sell the whole thing?

Returns. Such returns may be in the form of regular (or periodic) income, also known as current income; and capital appreciation, or capital gains.

The difference between the two: the current income is receivable periodically, without having to sell the investment, whereas the capital gains can be realized only when one sells the investment.

And exit charges cut across both: whenever there are any such charges for withdrawals (including early withdrawals), the same must be considered as a trade-off between liquidity and returns.

Convenience. Any investment must be evaluated in terms of convenience with respect to investing, taking the money out – fully or partially, as well as the investor's ability to conveniently check the value of the investment, as well as to receive the income.

Ticket size. What is the minimum amount required for investment? There are some avenues where an investor can start investing amounts as small as Rs. 50 or Rs. 100, whereas some require more than Rs. 1 lakh, and sometimes more than Rs. 1 crore.

With a caution about affordability being mistaken for suitability: some investors (though a very small number) have started considering certain investments (requiring large amounts), only because they could afford the same, without checking whether they needed it, or if that was appropriate for their situation and goals.

Taxability of income. What one retains after taxes is what matters. But while looking at the taxability of income, it is critical to evaluate various other factors, too, and not look at taxation in isolation.

Two examples of why: some products may offer lower tax on investment returns, but the safety also may be low. And there could be some products that may offer low tax on investment returns, only if the investor stays invested for a certain term, or till the maturity of the product.

Tax deduction. Such a deduction effectively increases the return on investment, since the same is calculated after factoring the net amount invested.

But it costs liquidity: where a deduction is available, the product may have a lock-in period of certain years. Once again, this is a trade-off between liquidity and tax deduction.

And the governing caution for all seven: no factor should be seen in isolation. One also must consider the investor's situation while evaluating the avenues.

1.2 The four asset classes

An asset class is a grouping of investments that exhibit similar characteristics.

The four broad categories— Real estate, Commodities, Equity and Fixed income.

And the fundamental split within them: out of these, real estate and commodities are also called real assets, whereas equity and debt are called financial assets. The real assets are available in physical form, whereas the other two would only be available in financial form.

Real estate

Real estate is considered as one of the important among all the asset classes. However, the popularity of this asset category is largely because of a reason not related to investment.

And the workbook makes an unusually blunt point about the family home: for those who have bought their own houses, it is the largest expense in life. The word used here is "expense", and not "investment". In majority of cases, individuals purchase for self-occupation. This should not be considered as investment, since selling the same may have a negative impact on one's lifestyle.

Its subcategories: residential real estate, land, commercial real estate, etc.

Its traits:

• Location is the most important factor impacting the performance of investment in real estate
• Real estate is illiquid
• It is not a divisible asset
• One can invest in physical real estate, as well as in financial form
• Apart from capital appreciation, it can also generate current income in form of rents
• In case of real estate, the transaction costs, e.g. brokerage charges, registration charges, etc. are quite high. This would bring down the return on investment
• The cost of maintenance of the property, as well as any taxes payable must be adjusted before calculating the return on investment, something that many individual investors do not

Commodities

People consume many commodities, e.g. agricultural commodities like spices; petroleum products such as petrol and diesel; or metals like gold and silver. However, it is not possible to invest in most of these, as many of these are either perishable and hence cannot be stored for long, or storage of the same could take a lot of space.

Why commodity derivatives are not investments — two reasons: (1) these are leveraged contracts, i.e. one can take large exposure with a small of money making it highly risky and (2) these are normally short term contracts, whereas the investors' needs may be for a long term.

Which leaves two: there are at least two commodities that many investors are quite familiar with as investment avenues, viz., gold, and silver.

They are global: when someone invests in these commodities, the prices are almost in sync across the world... In this manner, these two are globally accepted assets.

Gold's special status: gold has also been considered by many as a safe haven asset. In case of failure of an economy, or a currency, gold is considered to be the final shelter. Many currencies across the world were pegged to the gold reserves available with the central bank of the country for long. However, this so-called gold standard has been done away with few decades ago. And still, most of the central banks hold gold in their reserves.

The key limitation: an investor in these commodities would have to count only on capital appreciation, since these do not generate any current income.

And a practical problem: gold and silver come in varying degrees of purity... for a large majority of investors it is almost impossible to make out the level of purity. If we opt for purity certificate, the cost goes up and without one, the risk of getting lower quality metal is high.

Fixed income

When someone borrows money, one has to return the principal borrowed to the lender in the future. There could also be some interest payable on the amount borrowed. There are various forms of borrowing, some of which are through marketable instruments like bonds and debentures.

Who issues them: Companies, Union Government, State Governments, Municipal Corporations, banks, financial institutions, public sector enterprises, etc.

Where the return comes from: many bonds pay regular interest, thus the investors can expect current income. At the same time, if someone has invested at the time of issuance of the bond and hold the same till maturity, in almost all cases, there would be no capital gains.

Capital gains arise only through the secondary market: a transaction through secondary market – whether at the time of buying or at the time of selling, or both – may result into capital gains or losses.

On risk: bonds are generally considered to be safer than equity... However, these are not totally free from risks.

How they are classified: on the basis of issuer type i.e. issued by the government or corporates or on the basis of the maturity date (short term bonds (ideal for liquidity needs), medium term bonds, and long term bonds (income generation needs)).

Equity

This is the owner's capital in a business. Someone who buys shares in a company becomes a part-owner in the business. In that sense, this is risk capital, since the owner's earnings from the business are linked to the fortunes, and hence the risks, of the business.

The long-run case: historically, equity investing has generated returns in excess of inflation, which means the purchasing power of one's money has increased over the years. It has also delivered higher returns than other investment avenues, most of the times, if one considers long investment periods.

The workbook's figure: Sensex has grown from a level of 100 to 82,269 till 30 January 2026. This is an appreciation of around 15.4 percent p.a., compounded annually, before adding dividends.

Plus income: apart from long term capital appreciation, equity share owners may also receive dividends from the company. Such dividends are shared out of the profit that the company has generated from its business operations. If the company does really well, the dividends tend to grow over the years.

And the summary sentence worth memorising: equity share prices generally fluctuate a lot, often without regard to the business fundamentals. However, over long periods of time, the share prices follow the fortunes of the firm. If the profits of the company continue to grow over the years, the share price follows.

How the four compare

Physical versus financial: investments in equity and bonds can be done only in financial form, whereas one can buy the other two assets, viz., real estate and commodities either in financial or in physical form. It is this physical form that gives a feeling of safety to many. Anything that is tangible is perceived to be safer than something intangible.

Investment versus consumption: real estate and commodities... could be bought as investment or for consumption purposes. A rented-out flat is investment; a self-occupied house may not be an investment. A similar logic may be applied to gold and silver.

Which generate intermittent cash flow: equity may pay dividends, a real estate could be given on rent to generate intermittent cash flow. Bonds pay interest income. It is the commodities where such intermittent cash flow is not generated.

Commodities are the odd one out — no current income at all.

Ownership versus lending: investor in equity, real estate and commodities is an owner of the asset, whereas an investor in bonds has lent money to someone. In such a case, the lender's receipts—be it interest payments or return of principal amount invested – are agreed at the time of the issue of such instruments. In all the other three cases, the investor's cashflows (or receipts) are unknown.

Hence: the future returns from these assets, which may also be called ownership assets, would be highly uncertain in comparison to the lending assets like bonds or fixed deposits.

International assets: an investor may buy shares listed abroad, bonds denominated in various currencies other than Indian Rupee, or real estate abroad. These are called International assets. However, one must understand the basic nature of the asset class as discussed earlier, and then try to assess the impact of currency fluctuation on these investments.

The classification table

Note that insurance policies — endowment and moneyback — sit under Fixed Income, as do PPF, SSY and SCSS.

1.3 The four broad financial needs

When it comes to money, we all have four basic needs.

1. Transaction needs. The day-to-day life involves many transactions involving money. Income arrives through salary, business income, investment income, rent from house property; expenses go out for day to day living, or entertainment, or purchase of luxury items, or even charitable contributions.

These needs can be met with the help of the banking system.

2. Protection needs. Since most individuals depend on the earning (income) of one or members of the family to fund their current expenses and financial goals, they may get into financial difficulties if the income of one of the earning members stops prematurely. This may happen on account of death of the earning member or health issues.

Life and health insurance companies provide solutions to tackle such situations.

3. Investment needs. Mostly, the monthly income is higher than the monthly expenses. At the same time, every once in a while, there are expenses that one has to incur, which are far more than the income for the period.

These needs can be met by investing the regular monthly surplus in some investment products.

4. Retirement needs. This is a phase of life when the income stops, but the expenses continue.

And it has two phases: (i) preretirement phase, which is also called the accumulation phase; and (ii) postretirement phase, which is also known as the distribution phase. In the former, one can use various investment products; however, it is the distribution phase, where many different products like annuities would come in to the picture.

Four needs, four kinds of provider: banking system · life and health insurance companies · investment products · investment products plus annuities.

1.4 Financial goals

Among the most common are funding a child's education, cost of the marriage of one's son or daughter, funding the lifestyle in retirement, buying a vehicle, buying or renovating one's house, taking a big vacation. At the same time, there could be some not-so-common ones like starting one's own business, or taking a sabbatical from work and fund one's higher education.

Why goals need funding at all: all the financial goals are about the need of money that cannot be fulfilled through the inflow at that time... This is where money needs to be withdrawn from the investments – in other words, this is why one needs to invest the money.

The steps in goal setting:

First — identify. The first step in goal setting is to identify these events in life.

Second — prioritise. After identifying the events, one needs to assign priorities – which of these are more important than the others. Retirement, or children's education fall into the responsibilities category, whereas a grand vacation maybe a good-to-have goal.

But the choice is the family's: it is only the individual and the family that can decide which is which. A financial advisor or a mutual fund distributor may only guide and help one take an appropriate decision. At the same time, the role of such an intermediary could be very important.

Third — timeline and amount. After that, one needs to assign a timeline as well as amount of funding required at the time of such events. Both the timeline and amount are critical for one to be able to plan to achieve the goal.

The matrix that results classifies goals along two axes — critically important (responsibilities or needs) · dreams · good-to-have against immediate term · near term · medium term · long term.

And retirement splits in two: the retirement goal can be broken into two parts – accumulating a sum for retirement, and then taking income out of the corpus thus accumulated.

Inflation

In the process of planning, this is an important question: How much would it cost? Well, this question must be answered in terms of amount needed when the goal is due. In such a case, the costs are quite likely to move up. Such a rise in the cost of the goals is called inflation with respect to the goal value.

Inflation adjustment for the goal values is critical, without which the entire planning can go haywire.

Sapna's higher education — the workbook's case. Sapna is an 8-year-old girl... the estimated cost of her higher education is Rs. 10 lacs (in today's price), whereas Sapna would go to college 10 years later. If the inflation in college fees is expected to be 8% p.a., her parents need to provide for Rs. 21.59 lakh in 10 years, approximately.

Without the adjustment: the parents may plan to accumulate Rs. 10 lacs (today's cost of education), which would be grossly insufficient.

And the horizon matters: inflation has a long term impact, and hence while planning for funding all the long term goals, one must consider inflation in the cost of the goal. On the other hand, the immediate term and near term goals may not have a big impact due to changes in price.

The household example: if a family's monthly expenses are Rs. 30,000 currently, they would be spending Rs. 31,800 next year if the inflation is 6%. This does not look like much, but if the inflation stays at the same level, this family's monthly expenses would cross Rs. 53,000 after 10 years; and Rs. 96,000 after 20 years.

From ₹30,000 to over ₹96,000 in twenty years at 6%. That is the argument for taking inflation seriously.

1.5 The role of mutual funds

One option is to manage the investments oneself. That would involve finding the right investments and carrying out the related research and administration work. The other option is to outsource the entire job to a professional or a company engaged in such a business.

Mutual fund is that second option – it is managed by a team of professionals, known as the asset management company.

And a point the workbook insists on: by choosing to invest through mutual funds, one is not investing in alternative investment options, but only changing the way of investing money. The entire job of investing is outsourced to a professional firm.

A mutual fund is not a fifth asset class. It is a vehicle for investing in the four.

The three questions

1. Can one do the job oneself? This is the question about ability. In order to do a good job, there are a few requirements, viz., ability to do the job and the availability of time required for the same. In either case, one is unable to manage money oneself and should consider outsourcing it.

2. Does one want to do it? Even when one has the required skills and knowledge... it is very likely that one may not enjoy money management – either the research and analysis or administration or accounting. At the same time, one may want to spend time on one's main profession or on certain other activities, e.g. spending time with family and friends, pursuing hobbies.

3. Can one afford to outsource? There is some cost associated with mutual funds, since the agencies involved need to be paid their professional fees. SEBI has issued guidelines on the maximum amount that can be charged to the fund.

The comparison people get wrong

Most people make the mistake of comparing these fees with zero cost of managing one's own money oneself. By this comparison, the cost of mutual fund always looks higher between the two options.

What is missed out in this comparison is the hidden costs of doing the investment management job on one's own. This hidden cost comes in the form of one's time and the potential mistakes that an individual investor is likely to make.

The workbook's arithmetic: assume the investor matches the fund manager before costs, and the cost of fund management is 2% p.a. This means if one is able to generate 12% p.a. by investing oneself, the mutual fund scheme would return 10% p.a. net of the fund management charges. On a portfolio of Rs. 10 lakhs, this amounts to a saving of roughly Rs. 20,000 for the year.

Then the question: is it worth spending the amount of time one is required to spend for this saving? Please consider the amount of research one has to put as well as the administration and accounting work.

And the counter to the obvious objection: someone may start thinking that this means investors with smaller portfolios should invest through mutual funds, but the bigger ones should not. This is where the concept of value of time should be looked at. The value of time may be higher in case of people with more wealth.

The second hidden cost: the mistakes one is likely to make given the emotional attachment with one's own finances.

The conclusion: for most investors, mutual fund would turn out to be a better option than to build the portfolio oneself.