To enable the evaluation and a reasonable comparison of various investment avenues, the investor should study the following attributes:
1. Rate of return
Each of these attributes of investment avenues is briefly described and explained below.
1. Rate of return: The rate of return on any investment comprises of 2 parts, namely the annual income and the capital gain or loss. To simplify it further look below:
Rate of return = Annual income + (Ending price - Beginning price) / Beginning price
The rate of return on various investment avenues would vary widely.
2. Risk: The risk of an investment refers to the variability of the rate of return. To explain further, it is the deviation of the outcome of an investment from its expected value. A further study can be done with the help of variance, standard deviation and beta.
3. Marketability: It is desirable that an investment instrument be marketable, the higher the marketability the better it is for the investor. An investment instrument is considered to be highly marketable when:
- It can be transacted quickly.
- The transaction cost (including brokerage and other charges) is low.
- The price change between 2 transactions is negligible.
Shares of large, well-established companies in the equity market are highly marketable. While shares of small and unknown companies have low marketability.
To gauge the marketability of other financial instruments like provident fund (which in itself is non-marketable). Then we would consider other factors like, can we make a substantial withdrawal without much penalty, or can we take a loan against the accumulated balance at an interest rate not much higher than our earning rate of interest on the provident fund account.
4. Taxes: Some of our investments would provide us with tax benefits while other would not. This would also be kept in mind when choosing the investment avenue. Tax benefits are mainly of 3 types:
Initial tax benefits. This is the tax gain at the time of making the investment, like life insurance.
Continuing tax benefit. Is the tax benefit gained on the periodic return from the investment, such as dividends.
Terminal tax benefit. This is the tax relief the investor gains when he liquidates the investment. For example, a withdrawal from a provident fund account is not taxable.
5. Convenience: Here we are talking about the ease with which an investment can be made and managed. The degree of convenience would vary from one investment instrument to the other.