Choosing the right type of investment is far more important than the investment product. When you want to know where to invest your money, the worst question to start off with is the obvious one, that is, “which investment should I choose”. That sounds paradoxical — after all, if you want to make the right choice in terms of, say, a mutual fund, then you’ll have to ask which one. However, if that’s the question, then there’s practically no chance of getting the right answer.
Unfortunately, the way investments are sold, this query seems the first and most important one. The right question is “What type of investment should I choose”? Choosing an investment is not a bottom-up activity but a top-down one.
The process of deciding how to invest your money consists of layers of decisions. At the top layer, one has to figure the mix of assets such as equity, fixed income, real estate and such. This mix depends on your time-frame, risk-taking ability, need for income, age and such broad measures. At the next layer, you must decide what kind of investments should make up each.
For example, should the equity be equity mutual funds or direct investment in equity? Should the fixed-income investments be a bank FD or a post office deposit? Decisions you take at this layer are probably more driven by convenience and knowledge rather than by your needs. It’s only at the next layer that you decide which actual investment you should go in for.
The importance of thinking in terms of these asset allocation layers is that making the right decision at a higher layer is far more vital to your finances.
Advertising hype and salesman’s pressure are all focussed at the final product-choice stage. If you heed the noise, you could choose a product of the wrong type.
But if you have already chosen the right type, chances of a damaging decision are minimised.