Objectives and Principles of Investment
Why does an individual decide to save today instead of spending? The answer lies in the Objectives they wish to achieve. To reach these goals without losing their capital, they must follow established Principles.
1. Objectives of Investment
Investment objectives are generally divided into primary (financial) and secondary (psychological or strategic) goals.
A. Primary Objectives (The Big Three)
- Maximization of Return (Profitability): Every investor wants their money to grow. This includes regular income (like interest/dividends) and capital appreciation (increase in asset value).
- Minimization of Risk (Safety): Protecting the original amount invested. A common goal for conservative investors is to ensure they don't lose their "principal."
- Liquidity: The ability to convert the investment into cash quickly in case of an emergency without a significant loss in price.
B. Other Important Objectives
- Hedge Against Inflation: If the inflation rate is 6% and your bank gives 4%, you are actually losing purchasing power. Investors seek assets that grow faster than inflation.
- Tax Minimization: Investing in specific instruments (like insurance or mutual funds) to reduce the total tax liability.
- Support for Future Needs: Saving for specific milestones like buying a home, children's education, or retirement.
2. Principles of Investment (Criteria for Selection)
When choosing where to put money, an investor evaluates the "opportunity" based on these 6 guiding principles:
| Principle | Description |
|---|---|
| Security of Principal | The "First Rule of Investing." The primary capital must be safe from loss. |
| Adequacy of Yield | The return should be sufficient given the risk taken. It should at least cover the "cost of inflation." |
| Appreciation | The potential for the investment to grow in value over time (e.g., land or stocks). |
| Marketability | How easily can the security be traded on an exchange? Highly marketable securities like large-cap stocks are preferred. |
| Legality | The investment must be within the legal framework of the country (SEBI/RBI regulated). |
| Tax Considerations | Understanding the 'after-tax' return is more important than the 'gross' return. |
3. The Relationship Between Objectives
It is often impossible to achieve all objectives at once. This is known as the "Investment Triangle."
You cannot have high Return, high Safety, and high Liquidity all at the same time. If you want a high return, you must accept more risk (less safety). If you want instant liquidity, you may have to accept lower returns.
Exam Pattern Questions and Answers
Question 1: "Explain the various objectives of investment for a common investor." (6 Marks)
Answer: A common investor's objectives can be summarized into three main categories:
- Income and Growth: The most basic objective is to earn a profit. This can be regular monthly income (like pension or rent) or long-term growth (like buying a stock today and selling it for double in 5 years).
- Safety and Security: For many people, not losing their capital is more important than earning a high profit. This is why many stick to government bonds or bank fixed deposits.
- Liquidity and Flexibility: Life is unpredictable. An investor needs to know that a certain portion of their wealth can be withdrawn immediately if a medical or family emergency arises.
- Tax Planning: In modern economies, tax can eat up 20-30% of profit. Hence, a major objective is to invest in "Tax-Saving" schemes to keep more of the earnings.
Question 2: "What are the core principles an investor should follow? Explain 'Security of Principal'." (6 Marks)
Answer: The core principles include Security, Yield, Appreciation, Marketability, and Tax-efficiency.
Security of Principal: This is considered the most important principle. It means that the main amount of money someone starts with should not be lost.
- No one wants to invest ₹1,00,000 and find it has become ₹80,000 next year.
- While "Risk" is part of investing, "Security" means the investor has chosen assets where the chance of total capital loss is very low.
- For example, Government Savings Certificates have the highest security of principal because they are backed by the government.
Summary
- Objectives drive the choice of investment.
- Return, Risk, and Liquidity form the core triangle.
- Principles like Security and Yield are used to evaluate specific opportunities.
- A smart investor balances these rules based on their age and income.
Quiz Time! 🎯
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