Investment is the employment of funds on assets with the aim of earning income or capital appreciation. Investment has two attributes namely time and risk. Present consumption is sacrificed to get a return in the future. The sacrifice that has to be borne is certain but the return in the future may be uncertain. This attribute of investment indicates the risk factor. The risk is undertaken with a view to reap some return from the investment.
The investor makes a comparison of the returns available from each avenue of investment, the element of risk involved in it, and then makes the investment decision that he perceives to be the best having regard to the time the frame of the investment, and his own risk profile.
Any investment decision will be influenced by three objectives – security, liquidity, and yield. The best investment the decision will be one, which has the best possible compromise between these three objectives.
The best investment decision will be one, which has the best possible compromise between these three objectives. When selecting where to invest our funds, we have to analyze and manage the following three objectives.
(i) Security: Central to any investment objective is the certainty in the recovery of the principal. One can afford to lose the returns at any given point of time, but s/he can ill afford to lose the very principle itself. By identifying the importance of security, we will be able to identify and select the instrument that meets this criterion. For example, when compared with corporate bonds, we can vouch for the safety of return on investment in treasury bonds as we have more faith in governments than in corporations. Hence, treasury bonds are highly secured instruments. The safest investments are usually found in the money market and include such securities as Treasury bills (T-bills), certificates of deposit (CD), commercial paper or bankers’ acceptance slips; or in the fixed income (bond) market in the form of municipal and other government bonds, and in corporate bonds.
(ii) Liquidity: Because we may have to convert our investment back to cash or funds to meet our unexpected demands and needs, our investment should be highly liquid. They should be encashable at short notice, without loss, and without any difficulty. If they cannot come to our rescue, we may have to borrow or raise funds externally at a high cost and at unfavorable terms and conditions. Such liquidity can be possible only in the case of investment, which has an always-ready market and willing buyers and sellers. Such instruments of investment are called highly liquid investments. Common stock is often considered the most liquid of investments since it can usually be sold within a day or two of the decision to sell. Bonds can also be fairly marketable, but some bonds are highly illiquid, or nontradable, possessing a fixed term. Similarly, money market instruments may only be redeemable at the precise date at which the fixed term ends. If an investor seeks liquidity, money market assets and non-tradable bonds aren’t likely to be held in his or her portfolio.
(iii) Yield: Yield is best described as the net return out of any investment. Hence given the level or kind of security and liquidity of the investment, the appropriate yield should encourage the investor to go for the investment. If the yield is low compared to the expectation of the investor, s/he may prefer to avoid such investment and keep the funds in the bank account or in the worst case, in a cash form in lockers. Hence yield is the attraction for any investment and normally deciding the right yield is the key to any investment.