What is the Investment Process?
When we speak of investment, I am sure most of you would think of investing in some fixed deposit or investing in 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 investment process 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 behavior 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.”
5 Steps of Investment Process:
There are 5 investment process steps that help you in selecting and investing in the best asset class according to your needs and preferences.
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
Once the client’s needs and risk tolerance are understood, the next important step in the investing process is the Asset Allocation Decision. This crucial phase involves determining how to distribute investments across various asset classes, such as fixed income securities, equity, and real estate, to optimize returns while managing risk.
In today’s digital age, opening a demat account is a seamless and secure way to hold a variety of assets electronically. Allocating a portion of the portfolio to a demat account provides investors with efficient management and easy access to a range of financial instruments.
Investors should carefully consider macroeconomic conditions and overall market status during the asset allocation decision. Deciding on the proportion of investments in domestic versus foreign assets is also a key aspect. A well-thought-out allocation strategy can help balance the portfolio, ensuring diversification and resilience in the face of market fluctuations.
Step 3- Portfolio Strategy Selection
Third step in the investing 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 Process
Passive Management Process
Active Portfolio: Active 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: Passive 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 investing process steps 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.
Conclusion:
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.
FAQ’s-
1. What are the 5 Steps of Investment Process?
- Understanding the Client
- Asset Allocation Decision
- Portfolio Strategy Selection
- Asset Selection Decision
- Evaluating Portfolio Performance
2. Why is Investing Important?
Investing is crucial as it allows individuals to grow their wealth over time, achieve financial goals, and secure their future. It provides opportunities to outpace inflation, generate passive income, and build a diversified portfolio, ultimately leading to financial stability and independence.
3. What are the 5 Stages of Investing?
- Accumulation
- Consolidation
- Preservation
- Distribution
- Legacy
4. What are the Types of Investment?
- Stocks
- Bonds
- Mutual funds
- Exchange-traded funds (ETFs)
- Real estate
- Commodities
- Certificates of deposit (CDs)
- Retirement accounts (e.g., IRAs, 401(k)s)
- Cryptocurrencies
- Annuities
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