In the routine of our lives, the term 'financial instruments' or terms to that effect often float around us. We catch glimpses of it in the news, and overhear elders animatedly talk about it, yet how many of us truly comprehend what these instruments entail? Especially for the youth, the world of investments might seem like an exclusive club, discussed but not fully understood. Often, we make investment decisions without fully exploring our options, and that's where the knowledge of financial instruments becomes a game-changer.
It's time to demystify these financial enigmas and unlock the door to a world where you can actively shape your financial future.
Beginning from the basics, what are financial instruments?
Financial instruments are like tools you can use to grow your money. Imagine them as different ways you can invest your cash to make more cash.
There are two main types: one where you actually own something, like a share of a company (that's a stock), or you lend money to someone, like when you buy a bond.
The other type is a bit more complex and depends on the value of something else, like how the price of gold changes.
So, investing means putting your money into these tools with the hope that it will grow over time. You might buy a bit of a company or lend money to the government.
But, why do we buy these investments?
Because these investments have the potential to earn you more money than just letting your cash sit there.
Although, the type of investment you choose depends on what you want to achieve and how much risk you're comfortable with.
A quick recall to what the term ‘Interest’ means: Interest earned is the rate at which an investment earns value on your principal amount.
So what are these financial instruments and what do they look like?
Here is a list of investment instruments that are most common among the Indian investors:
Fixed Deposits (FD):
What is a Fixed Deposit?
An FD is a popular investment option in India with nearly every household that invest their money has at least one investment in an FD.
When you opt for an FD, you're essentially lending a sum of money to a bank or financial institution for a fixed period at a predetermined interest rate. The characteristics of FDs include a fixed tenure, usually ranging from a few months to several years, and a guaranteed interest rate that remains constant throughout the investment period.
FDs are known for their secure nature and low risk, making them ideal for conservative investors who prioritize capital preservation over high returns.
What do the returns look like?
The average return on FDs tends to be moderate, offering a reliable but relatively lower interest rate compared to other investment avenues. Interest income from FDs is generally higher than regular savings accounts, providing a steady source of earnings.
Who is it most suitable for?
FDs suit individuals with a low-risk appetite, such as retirees, who seek a safe investment to generate regular income. They also appeal to those with a specific financial goal in mind, like saving for a down payment on a house, where capital protection is crucial. While FDs may not provide the highest returns, their predictability and stability make them a preferred choice for risk-averse investors looking for a secure and fixed-income investment option.
Mutual Funds:
What are Mutual Funds?
Mutual Funds are a dynamic investment option in the Indian financial instruments landscape. Essentially, a Mutual Fund pools money from numerous investors to invest in a diversified portfolio of stocks, bonds, or other securities managed by professional fund managers.
Simply put, a fund manager manages the pool of money that is invested by you and others like you. They invest this money based on their expertise, eliminating the need for you to actively watch for investment opportunities and know about what and when to buy securities.
It is particularly helpful when you want to invest in a variety of stocks or bonds across multiple industries but do not have the required amount of money to invest in each of them. The stock price of a company can be significantly high. Mutual funds enable you to have a fractional ownership of a share commensurate to the amount of money you invest.
The characteristics of Mutual Funds include diversification, liquidity, and professional management, making them an attractive choice for investors seeking exposure to various financial instruments without directly managing their investments. To understand this better, there are different types of mutual funds, with ones that have a higher risk associated with it with higher chances of returns. And conversely those with less risk but also lesser potential returns.
What do the returns look like?
The average return on Mutual Funds varies based on the type of funds chosen. Equity Mutual Funds, investing primarily in stocks, may offer higher returns but come with higher volatility. Debt Mutual Funds, focusing on fixed-income securities, tend to provide more stability but with relatively lower returns. Hybrid Mutual Funds strike a balance by combining both equity and debt instruments.
Who is it most suitable for?
Mutual Funds cater to a broad user profile, suitable for investors with varying risk appetites and financial goals. Young professionals with a higher risk tolerance might opt for equity-oriented funds for long-term wealth creation. On the other hand, conservative investors, such as retirees, might lean towards debt funds for capital preservation.
Systematic Investment Plans (SIPs) within Mutual Funds offer a convenient way for investors to contribute regularly, fostering financial discipline. Overall, Mutual Funds provide a versatile investment option tailored to individual preferences, financial objectives, and risk tolerance.
We covered Fixed Deposits and Mutual Funds in this article.
Join us in the next article where we continue about the other investment options. Also, check out our FAQs there!