How To Choose A Financial Product?

How To Choose A Financial Product?

When it comes to choosing financial products, a checklist is hardly on our radar. Most rely on random tips from friends, peers, or agents to invest our hard-earned money in different instruments without thinking twice.

Needless to say, such an approach can cause significant heartburn later. It’s crucial to adopt due diligence while opting for financial instruments, and this checklist can be your handy guide.

·        Have a Holistic View of Your Goals

Before getting started, let’s get back to the basics and have a holistic view of your goals. Understand what you want to achieve by investing in a particular product. Divide your goals into three broad categories - short-term, medium-term, and long-term. 

The table below highlights various examples under these categories and their tentative duration:

·        Ensure the Product’s Risk Aligns with Your Risk Tolerance

Every financial product carries an element of risk. Before choosing, make sure the product’s risk matches your risk tolerance. There’s little point in investing in a financial instrument whose risk structure is different from yours. Doing so will rob you of your peace of mind. 

For instance, if you have a conservative outlook and invest in pure equities that are volatile and risky in the short term, it can make you nervy when markets nosedive. Hence, it’s prudent to invest in products that match your risk profile.

·        Find out the Real Rate of Returns

Real returns are returns that you earn up and above the inflation. Inflation has a decompounding effect on money and reduces your purchasing power. Hence, it’s crucial to gauge the real rate of returns and invest in instruments that generate positive returns. 

For example, if the rate of inflation is 7% and your financial instrument generates 6% returns, you are losing out on 1 percentage point. Also, consider post-tax returns as if you fall in the highest tax bracket as it further erodes your gains.

·        Liquidity

Liquidity refers to the ease with which you can convert your investment into money without eroding its value. Find out if the product has any lock-in period and if you can exit midway. Some financial instruments such as PPF and ELSS have a lock-in period of 15 years and three years, respectively. 

On the other hand, stocks and mutual funds are highly liquid. The proceeds are credited into your account in a few days. For short and medium-term goals, it’s not prudent to invest in non-liquid instruments. However, you can invest in products with a long lock-in period for long-term goals as it gives your money more time to grow and brings compounding into play.

·        Ease of Transaction and Costs

Time is one of the most valuable assets. Hence, ease of transaction is a crucial parameter to factor. Find out about online options available to invest in the product and gauge the amount of paperwork required. Digitalization has made transactions easy for most financial products. 

Cost is another essential aspect to consider. Closely look at the entry and exit cost, particularly for market-linked products. For instance, while most mutual funds have zero entry cost, you need to pay an exit load if you redeem within a year of investment. For others, such as unit-linked insurance plans (ULIPs), the entry cost can vary from 5%-10%.

·        Conclusion

Keeping in mind the above aspects will help you make a prudent choice and ensure you pick up an instrument that seamlessly aligns with your life goals.

Source: edelweiss.in