How to think of long term and short term investment strategy?
'Keeping money in a fixed deposit is safe and investing in equity is risky'. 'Real estate investing is less risky than equity investing'. 'Will I lose my capital ?'. And the list goes on. Are these the right questions to answer when you plan your investments.
Let's reflect on how investment textbooks define risk. Volatility or the movement in value is usually shown as a proxy of risk. More volatile the asset value is, riskier the asset becomes. Warren Buffet, legendary investor defines risk as "Risk of not knowing". Most of the people are not aware of what they are investing in.
The only investment product I can think of that can be categorized as the lowest risk in a country is a 'government bond'. It's the lowest risk because these bonds are backed by the 'government'. India's credit rating is BBB-, which is the lowest investment-grade rating. If the rating goes below BBB- then the bond is categorized as non-investment grade and the likelihood of default increases. So the perspective I want to share is even our government bond can default.
So what do you do? Do you expect your capital to go down? Do you just park your money in a government bond? No, you educate yourself and know what you are investing into. After working with various clients, I have realized that the majority of people think in three ways about their investments: Short-term, long-term, don't care.
Short-term: These investments are done to meet short-term needs, say less than five years. You can invest your money in a fixed deposit. To increase the post-tax return you can also evaluate investing in short-term bond funds.
Always ensure that you do not chase extra 1-2% by assuming the risk of capital loss.
Long-term: These are the objectives that you plan to achieve the post for five years. I recommend equity-based investing. You can have a combination of mutual funds including index funds.
If you have certain industry knowledge, direct equity investment may also be part of your portfolio. With direct equity, you would invest in those stocks that are not tracked by mutual fund houses. Just maintain 4-5 stocks in this bucket and that's it.
Invest in real estate if the investment horizon is more than fifteen years. Ensure that you invest in constructed properties and there is no risk of capital loss.
Don't care: Please note the category is 'don't care' and not 'don't know'. If you have additional cash that you don't care, you should invest in an equal split between equity and debt/bonds.
If you define the objective, creating an investment strategy is a lot simpler. If you have clarity of the objective, you will be comfortable to handle short-term fluctuations. Reflect on your needs and decide the allocation, you will feel a lot better managing your wealth.