Five types of investments to avoid.
Everybody has an opinion as to where should an investor invest money. However, rarely people tells you which investments to avoid. In this blog, we will be discuss about some popular investment options which are not beneficial for the investor.
Here are five types of Investments to avoid.
Life Insurance is one the most important tool to provide financial protection to your family. Everyone must buy a term insurance policy so that you do not have to worry about the well being of your family, in case you are not around.
However, as an investment vehicle, Life Insurance is sub-par. Life insurance investment plans are complex to understand and their returns are sub-optimal. There are two types of Life Insurance investment categories.
a) Endowment Policy: Endowment policy is a combination of insurance and investment. A certain part of the premium gets allotted towards the sum assured for life cover and remaining portion gets invested. The endowment policy declares bonus every year. This is nothing but the returns on the money invested. This bonus is not payable immediately. An investor on an average would earn 5-6% in such policies which are lower than even Bank Fixed Deposits.
b) Unit Linked Insurance Plan: This plan also combines investment and insurance. These plans invest in stock markets and bond markets just like mutual funds. However, there is an insurance component too for which you have to pay charges. Apart from that there are many other charges in a ULIP like, Policy Management, Premium Allocation etc. Hence it is not easy to understand how much charges you are paying for a ULIP plan. Also, the returns on investment have not been very impressive in ULIPs.
There is a tendency in India to invest in real estate once you have some spare money. People want to invest in the asset class that they can see since there is a mental comfort. Save a little for down payment, take a loan and buy a house. This could be a good strategy, if you are living in the house that you buy. However, if you are buying a house just for investment, then it is not a prudent decision. There are many reasons for that:
a) High transaction costs:
The stamp duty and registration fees are very high as compared to other investment plans where the transaction cost is much lower thus reducing the profits earned on an investment in real estate.
b) Requires large capital to invest in this asset class:
In order to invest in asset class like this you require a larger capital in the initial stage to start with.
c) Cost of maintaining property is high:
Cost of maintaining a real estate property is very high. The management cost in order to deal with the property’s day to day operation is higher.
d) Very low liquidity:
Real estate by nature is an illiquid asset. You cannot buy or sell it easily. Hence, if you need the money in emergency then you may not be able to do so. Also, it takes a lot of time and planning to sell a house.
e) Low returns as compared to other asset class:
There is a misconception that real estate gives very high returns. This may be true in some cases where the investors got lucky due to development in the area. However, on an average the returns from Real Estate have been around 10%-12% only. If you add the cost of maintenance of the property and other incidental charges, then the returns are even lower.
Buying a house as own residence can be a good option but real estate as an investment should be avoided.
This asset class is similar to that of real estate, where people invest with a similar mindset as this metal can be seen and used and the value of this metal has increased in long run. There is an emotional value attached to this metal. But when we look to gold as an investment it shouldn’t be preferred for following reasons:
a) Value is lost in making charges:
You have to pay high making charges, especially for some exotic designs. The making charges are as high as 10-12% which you won’t be able to recover in case you decide to sell.
Since all the investors have an emotional value attach to gold the sentiment acts as the hindrance at time of uncertainties.
c) No regular Income:
This asset doesn’t provide any regular income, whereas investments made in mutual funds, stocks and real estate generates dividend and rental income.
d) It has only beaten inflation in long run:
In recent past the returns on gold were high, but if we judge in long run gold has just managed to beat the inflation in long run. Historically inflation has been 6-7% approx and gold has given returns up to 8-9% which is comparatively less than other investment options.
Fixed Deposits are financial instruments provided by bank or NBFCs which provide the higher rate of interest than regular savings account till the date of maturity. The returns are fixed hence the investor knows how much money he/she is going to get. However, with falling interest rates and advent of debt mutual funds, fixed deposits are not an attractive option anymore.
Debt fund is an investment pool where the funds are invested in fixed income investments. In various short term and long term bonds, securitized products, money market instruments or debt. We will now see how a Debt fund is better than Fixed Deposits.
Returns from bank fixed deposits are treated as interest and are taxable. Many investors who come in the tax bracket of 30% have to pay the large chunk of tax on the interest income. The tax rate in case of debt funds for less than 3 years is as per the tax slab. But long-term debt funds are taxed at 20% after indexation which enhances the post tax returns.
Debt funds are more liquid as compared to Fixed Deposits. In case of debt funds, they have exit loads or charges for redemptions typically up to 3 years. Fixed Deposits carry a penalty if redeemed before the maturity date.
Returns on debt fund are better than the fixed deposits. Short term debt fund category have given on average return of 8.55% in last 3 years and there are many good funds available which have given even better returns.
Bitcoin is the latest buzzword in the financial market. Bitcoin is a type of cryptocurrency.
A cryptocurrency is a digital/virtual currency and is secured by cryptography. This type of currency is not issued by central authority hence there is no interference of government. Despite the headline making high returns of cryptocurrency, there are a lot of issues with it.
a) Very Risky
Investing in cryptocurrencies is very risky. Since there isn’t an ecosystem surrounding these cryptocurrencies, these become difficult to analyse. With the rising prices and imperfect information, it might lead to the formation of a bubble that can eventually burst and the investor can incur very heavy losses.
b) Highly Volatile
These currencies are highly volatile. The fluctuation in prices is very high. The prices are so highly volatile that within a fraction of the time it falls and then suddenly rises. Thus investing in such asset class is risky.
c) No clarity on legal aspect
There is no legal framework for these cryptocurrencies. The regulators have still not achieved sufficient clarity as to how to treat these digital currencies.
d) Accepted at very few places.
This asset class is not accepted by all the companies or websites. In case you want to purchase something through these cryptocurrencies, you first have to find a service provider that accepts it. This becomes difficult for an investor to transact through it.
Most of the investors are inclined towards traditional investment avenues while some take unnecessary risk. However, one can invest in mutual funds which offer plans for each type of risk tolerance and time horizon and can take the benefit of best in class returns.
– Written by Prachi Dosani