Four Methods to Choose Investment

One of the most common questions investors ask is: “Which investment should I choose?” The real answer is that no investment is good or bad in isolation.

A simple way to judge any investment is the RRLT framework - Risk, Return, Liquidity and Time Period. Before investing in any product, all four factors should be seen together.

1. Return

Return is the reward you expect from the investment. It may come in the form of interest, dividend, capital appreciation or regular income. Naturally, every investor wants good returns.

However, return should be understood properly. It is important to look at the real intrinsic / internal rate of return (IRR) of every investment, especially when cash flows happen at different points of time. A product may sound attractive on the surface, but the actual return may be very different when calculated correctly.

2. Risk

Risk is the possibility of losing money whether partially, fully, temporarily or permanently. In some investments, the risk is very low. In others, the value may fluctuate significantly in the short term.

Direct stocks, equity mutual funds, gold and real estate can create wealth over time, but they need patience and the ability to tolerate ups and downs. On the other hand, fixed income products may offer stability, but they may not beat inflation over the long term.

3. Liquidity

Liquidity means how easily you can convert your investment back into money when required. A savings account is highly liquid. Fixed deposits, mutual funds and stocks are reasonably liquid. Real estate may take time to sell.

Liquidity matters because emergencies do not come with advance notice. Before chasing returns, every investor must ensure that enough money is available in liquid instruments for short-term needs and emergencies.

4. Time Period

Time Period is the most important filter. The investment product should be selected based on when you need the money.

If the money is needed within a few months or one to two years, safety and liquidity matter more than high returns. If the goal is ten, fifteen or twenty years away, growth-oriented assets like equity mutual funds, direct stocks and gold-related instruments can play a larger role.

The longer the time horizon, the better your ability to handle short-term volatility.

Goal-Based Planning

This is where proper financial planning becomes useful. Make a table of your financial goals - home purchase, car, vacation, child education, child’s marriage and retirement.

Write the amount required, adjust it for inflation and mention the time left for each goal. Once this is clear, choosing the right investment becomes easier.

Investment Avenues

Broadly, investment avenues can be divided into two categories - those that help beat inflation and those that mainly provide stability.

Equities, equity mutual funds, gold and real estate help in long-term wealth creation by beating inflation. Your long-term financial goals should ideally be invested in this bucket - the one that helps your money grow faster than inflation.

For your short-term goals, rely more on bank fixed deposits, recurring deposits, and debt mutual funds. Here, safety and availability of money are more important than high returns.

A good investment is not the one that sounds exciting. A good investment is the one that fits your goal.

So before investing anywhere, remember RRLT - Risk, Return, Liquidity and Time Period. When these four are aligned with your financial goal, investment decisions become much clearer.

(The writer is Chartered Accountant and CFA (USA). Financial advisor. Views personal. He could be reached on 9833133605)