When we speak of investment, I am sure most of you would think of investing in some fixed deposit or a property or some of you would even buy gold. But there is much more to investing. An investment is the purchase of an asset with an expectation to receive return or some other income on that asset in future. The process of investment involves careful study and analysis of the various classes of assets and the risk-return ratio attached to it.
An investment process is a set of guidelines that govern the behaviour of investors in a way which allows them to remain faithful to the tenets of their investment strategy, that is the key principles which they hope to facilitate out-performance.
There are 5 investment process steps that help you in selecting and investing in the best asset class according to your needs and preferences. Read here is details every notes on investing process.
Step 1- Understanding the client
The first and the foremost step of investment process is to understand the client or the investor his/her needs, his risk taking capacity and his tax status. After getting an insight of the goals and restraints of the client, it is important to set a benchmark for the client’s portfolio management process which will help in evaluating the performance and check whether the client’s objectives are achieved.
Step 2- Asset allocation decision
This step involves decision on how to allocate the investment across different asset classes, i.e. fixed income securities, equity, real estate etc. It also involves decision of whether to invest in domestic assets or in foreign assets. The investor will make this decision after considering the macroeconomic conditions and overall market status.
Step 3- Portfolio strategy selection
Third step in the investment process is to select the proper strategy of portfolio creation. Choosing the right strategy for portfolio creation is very important as it forms the basis of selecting the assets that will be added in the portfolio management process. The strategy that conforms to the investment policies and investment objectives should be selected.
There are two types of portfolio strategy.
- Active Management
- Passive Management
Active portfolio management process refers to a strategy where the objective of investing is to outperform the market return compared to a specific benchmark by either buying securities that are undervalued or by short selling securities that are overvalued. In this strategy, risk and return both are high. This strategy is a proactive strategy it requires close attention by the investor or the fund manager.
Passive portfolio management process refers to the strategy where the purpose is to generate returns equal to that of the market. It is a reactive strategy as the fund manager or the investor reacts after the market has responded.
Step 4- Asset selection decision
The investor needs to select the assets to be placed in the portfolio management process in the fourth step. Within each asset class, there are different sub asset-classes. For example, in equity, which stocks should be chosen? Within the fixed income securities class, which bonds should be chosen?
Also, the investment objectives should conform to the investment policies because otherwise the main purpose of investment management process would become meaningless.
Step 5- Evaluating portfolio performance
This is the final step in the investment process which evaluates the portfolio management performance. This is an important step as it measures the performance of the investment with respect to a benchmark, in both absolute and relative terms. The investor would determine whether his objectives are being achieved or not.
What is an Investment Decision?
The investment decision is finance terminology related to a decision made by the investors concerning the amount of funds to be invested in the various investment vehicles.
An investment process is a set of guidelines required to create the portfolio and sequence of actions involved, from defining the risk parameters to asset allocations. It gives a structure to the investor who helps him implement the strategy customized as per his goals, objectives, risk tolerance, and values that seek to manage the risk. All in all, it is the process that makes an investor a confident investor that can make decisions effortlessly without any self-doubt. If you are a newbie investor and want satisfactory investment returns, then you should incorporate an investment process in your investment strategies.
Simply, select the types of assets in which the investor as the investment decision invests the fund. There are two types of assets.
The investment decision of investing in long-term assets is also called capital budgeting. Thus, the capital budgeting is the process of selecting the assets that will give you return over a long period of time. For example, investing in mutual funds, stocks, bonds, and real for more than a year comes under a long-term financial decision.
The first step involved in capital-budgeting is to choose the asset. The return of the investment depends on the type of asset you choose. The higher you take risk, the better return you will get. So, while making an investment decision, always consider your risk appetite.
The investment made in current assets or short assets is known as working capital management. In which an investor tries to balance between profitability and liquidity. The process of investment decision involves both long-term assets and short-term assets. If you have a good knowledge of the market, and know the investment process very well, then we advise you to choose capital budgeting over current assets.
Nature of Investment Decision
The investment decision is a crucial decision for every investor as it determines profitability. It is advisable to do a proper study of risk and return before making any investing decisions. Let’s look at the nature of investment decisions and understand why it is important in finance.
1. Requires Huge Funds
An Investment decision requires a huge fund to be invested by a firm to gain profit. This decision is very crucial because firms have limited funds and demands for funds are very high. Every firm should necessarily design the investing process and control its expenditures.
2. High Degree of Risk
The investment decision involves a high amount of risk if they are taken based on the estimated returns. Large funds invested in the current assets are totally at risk. The market patterns fluctuate, which will show an adverse effect on the investment decision.
3. Long Term Effect
Investment decisions have a long-lasting effect on future profitability and firm stability. Your investment decision determines the growth of the firm and future. In case, if you make any wrong investment decision, it may ruin your personal and professional growth. Whereas, the right investment decision brings a good return of the investment, and your company’s growth to the next level.
4. Long-term commitment of funds
Funds are invested for a longer-term by an investor through this investment decisions. He deployed a large amount of capital for a long period permanently—a financial risk in investment decisions increases due to the long-term commitment of funds. An investor should properly plan and monitor all of his capitals.
Investment decisions are uncertain because they are taken on the basis of future events. Future cash flow and return of the investment cannot be predicted accurately as they are influenced by the market conditions, economic, social, political, and technology factors.
Scope of Investment Decisions
Scope of Investment Decisions Identify Degree of Risk. Here are those decisions help in identifying the level of risk associated with an investment opportunity.
1. Selection of Right Assets
An investment decision is the important aspect of the investment process as it helps investors to choose the right assets. Each available opportunity is properly analyzed by an investor while taking a financial decision. This way, every aspect of asset available for investment is considered, which leads to building a strong portfolio.
2. Identify Degree of Risk
This financial decision helps you to identify the level of risk associated with the investment. Your investing decisions are taken on the basis of the return and risk required for earning such a return. With the help of asset tools you can properly manage your risk,and make your portfolio strong and risk-free.
3. Determines Profitability
Investing decisions regarding investment plans determines the future profit-earning potential of the firm. If you make the right financial decision, it brings a large amount of funds to your company. Whereas, any wrong investment decision may cause a huge loss.
4. Enhance Financial Understanding
Investing decisions impart a vast knowledge about finance to the individuals making these decisions. When making investing decisions, investors take the help of a wide variety of tools and techniques to analyze the right assets and make sure their financial decision is right.
Types of Investment Decisions
There are several types of investment decisions. Below we have mentioned the important ones.
1. Inventory Investment
Inventory investment is a measurement of the change in inventory levels in an economy from one time to another. The expenditure of the stocks lies in this category.
2. Strategic Investment Expenditure
In this case, a firm makes the investment decision to strengthen the market power. Here they will not get the return immediately.
3. Expansion Investment on a New Business
In this case, a firm decides to open a new business; all the expenditure is done on purchasing machines that come in the expansion investment decision on a new business.
4. Replacement Investment
In this case, a firm makes an investment decision to replace the worn-out assets with new ones.
5. Expansion Investment
In this category, the firm takes decisions to improve its production capacity to increase the supply chain.
After all the above points have been followed, the investor needs to keep monitoring the portfolio management performance at an appropriate interval. If the investor finds that any asset is not performing well, he/she should ‘re balance’ the portfolio. Re balancing means adding or removing (or better call it adjusting) some assets from the portfolio to maintain the target level. Re balancing helps the investor to maintain his/her level of risk and return.
As an investor we would all likely beat the market, buying and selling the stocks based on excellent timing, strategies, and a little luck. But, most of us realize that it’s not that easy. Keeping an eye on the market trends out the clock, asking brokers which company is doing good can help you make the right investment decision. But you should incorporate a sustainable investing process that allows you to hit the market alone. That’s because the investment process provides you with a systematic way to create and handle a portfolio aligned with your financial goals while seeking to manage the investment risk.