Chapter 10

Selecting the Right Investment Products for Investors

 Physical Assets and Financial Assets
• Physical assets have a physical and material form
– E.g., gold and real estate
– Return is usually in the form of appreciation over time
– Physical assets are typically preferred by investors due their tangible nature
– Exposed to hazards such as fire, theft or floods, which may erode their value.

• Financial assets involve investing money for some cash flows

in the future
– Underlying claim or entitlement to interest, dividends or principal invested
does not have a tangible form
– E.g., Bank deposits, company deposits, equity shares, government saving
instruments, bonds and debentures
– Protected from physical harm
– Help in financing the economic activity
– Encouraged by government over physical assets
 Guaranteed and Non-Guaranteed Investments

• Guaranteed Investments
– Principal or interest or both are assured by an
agency like the government
– E.g. Government saving schemes

• Non-Guaranteed Investments
– Investments that do not provide any guarantee for
periodic payouts or return of capital
– E.g. equity shares, debentures and mutual funds
 Gold as an Investment

• Hedge against inflation

• Holding gold in the physical form
– Gold bonds, Gold coins and bars.

• Holding gold in the financial form

– Buying gold in the commodity futures market
• Traded in commodity exchanges like the NCDEX and
MCX with prices linked to gold prices
– Buying gold-linked funds
– Buying gold exchange traded funds (ETFs).
• Indian Mutual Funds’ Gold-linked funds
– Gold ETFs
– International gold funds
– Securities of gold mining companies.

• Advantages of holding gold in financial form

– Gold-based mutual fund schemes and ETFs are
exempted from wealth tax
– Investments in gold mutual funds are long-term
capital assets after a holding period of one year
– Mutual fund schemes offer nomination facility to
investors, not available in physical gold
• Indian Mutual Funds’ Gold-linked funds
– Gold ETFs
– International gold funds
– Securities of gold mining companies.

• Advantages of holding gold in financial form

– Gold-based mutual fund schemes and ETFs are
exempted from wealth tax
– Investments in gold mutual funds are long-term
capital assets after a holding period of one year
– Mutual fund schemes offer nomination facility to
investors, not available in physical gold
 Real Estate as an Investment
• Real Estate holding in physical form
– Preferred by investors
– Is beyond the means of small investors
• capital required is large
• transaction costs may be high.

– Not easy to quickly liquidate investments in real estate at an appropriate

price.

– Risk of concentration is high

• Not easy to diversify.

• Real Estate Mutual Funds (REMFs)

– Enable investors to receive benefits of investing in real estate with a
small investment
– Direct investment in real estate, debt instruments issued by developers, or
securitised loans
 Bank Deposits

• Preferred form of investment with small

investors
– Facility to access funds anytime
– Familiarity with their bank
– Considered safe investment option
• Limitations of bank deposits
– Penalty for premature withdrawal
– Yield on bank deposits is quite low
• Effect of inflation on returns
 Investors cannot benefit from changes in interest rates
» No possibility to benefit from capital gains in a falling interest rate scenario
• Interest income from bank deposits is taxable
Post-tax returns from bank deposits can be lower as compared to debt mutual funds for an investor in
a high tax bracket
 Equity Shares

• Popular among urban investors

– Represents part ownership in the company
• Investment in equity shares offers:
– Growth potential and appreciation of capital invested
– Liquidity from listing on stock exchanges
– Higher long-term returns as compared to other investment
options
• Not easy for retail investors
– Need research support, as well as expertise to select the
right stocks
– Need a large amount of capital to create a diversified
portfolio of equity shares
• Mutual funds offer the advantage of diversified and
 Debentures / Bonds and Company
Deposits
• Debentures/bonds represent borrowings of companies
– Pay a floating or fixed rate of interest
– Privately placed to institutional investors
• Debentures offered to retail investors have to be secured by the assets of the
borrower and are listed on the stock exchanges
– Liquidity of debentures is quite low and investors may end up holding them to
maturity
– Investors must be wary of instruments offering a high rate of interest, as they
can have a low credit quality
• Company deposits are unsecured deposits to investors
– Pay regular interest on the deposit and return the principal on maturity
– Compulsorily credit rated
– Rate of interest is usually higher than that of bank deposits because the credit
risk is higher
– Interest on company deposits is taxable
– Liquidity is low and investors have to hold them to maturity
• Investors in company deposits must be wary of default risk
 Institutional Bonds
• Financial institutions such as IFCI, NABARD and NHB issue
bonds
– Listed on stock exchanges
– Usually offered with two options:
• Periodic interest payments (monthly, quarterly or annual)
• Deep discount option that pays no interest but has a redemption
value which is higher than the issue price.
– Unsecured and have to be compulsorily credit rated.
• Infrastructure bonds for tax saving
– Infrastructure bonds are eligible for tax benefits under Section
80C of the Income Tax Act (deduction up to Rs 1.20 lakh on
amount invested)
• Infrastructure bonds for saving capital gains
– Investment of capital gains within 6 months, in such notified
bonds, exempts the investor from paying capital gains tax on the
amount invested (Section 54 EC)
– Notified bonds are bonds issued by NABARD, NHB and NHAI
 Public Provident Fund (PPF)
• Risk-free deposit that is made with the government
– Can be opened by individual investors
– An individual can have only one PPF account in his or her name
– Annual contribution (deposit by the investor into the PPF
account) can be between Rs 500 to Rs 70000
– Compulsory to make deposits every year
• Penalties are levied
 Contributions up to Rs 70000 per annum are eligible for tax deduction
under Section 80C of the Income Tax Act.
 Contributions have to be made for 15 years
 Tax-free interest rate fixed by the government, currently at 8% per
annum
– Interest is compounded
– Interest rates have fallen from 12% to 8% p.a.
 Limited liquidity
 Interest and the redemption proceeds at maturity are exempt from tax
 Small Saving Schemes
• Run by National Small Savings Organisation through the state governments
– National Savings Certificate (NSC), Kisan Vikas Patra (KVP),
Senior Citizens’ Savings Scheme and post office saving
schemes
– Preferred by small investors
– Guarantee on principal and interest
– Offer a fixed, but low rate of interest and are bought for
their safety than for their return
– Have to be held until maturity
• Very limited liquidity
– Interest rates are fixed by the government, and revisions
are not done very frequently
• Last revision was in 2002
 Insurance
• Life insurance
– Protection against loss of income due to unexpected death or
disability of an earning member
– ‘Sum assured’ is the obligation of policy holder
– Require the payment of regular premium by the policyholder
• Surrender value is paid out in case of termination of policy.

• Types of life insurance policies

– Pure term policy, where the sum assured is paid to the nominee
on the policyholder's death.
– Endowment policy, where the sum assured, along with
accumulated bonuses, is paid to the nominee in case of the
death of the policyholder or to the policyholder on the maturity.
• Investors seek insurance both for protection
and as an avenue for savings and investment
– Compulsory saving e.g. ULIP
– Tax benefits u/s 80C.

• Insurance is primarily as a protection product

and not an investment or tax saving product
– Term policies do not offer any return
– Investors tend to over-commit premium
– Many policies offer limited flexibility
 New Pension Scheme
• Launched in May 2009 is regulated by PFRDA
• Save for a retirement corpus
– Contributions made by the individual are managed by professional portfolio
managers
– No guarantee of returns
– The minimum investment is Rs.500 a month or Rs.6000 annually, with no
upper limit on investment
– Managed according to the investment mix selected by the contributor. The
options available are equity (E), credit risk bearing debt instruments (C) and
government securities (G)
•Investor can invest the entire corpus in C or G, investment in E is capped at 50%
•Auto choice option where the exposure to equity keeps reducing as the age of the
contributor increases
• Open an NPS account through identified Points of Presence
– Tier I (Pension account). The amount invested cannot be withdrawn before
the end of the term.
– Tier-II (Savings account). The amount invested can be withdrawn to meet any
financial contingencies.
– Permanent Retirement Account Number (PRAN) will be allotted