You
don't have to be wealthy to be an investor. Investing even a small amount can
produce considerable rewards over the long term, especially if you do it
regularly. But investing means you have to make decisions about how much you
want to invest and where to invest it. To choose wisely, you need to know what
choices you have and what risks you take when you invest in different ways.
Different people have different reasons for
their financial actions – whether to save, invest, or to spend it all.
Investing is not an overnight phenomenon. It is a financial commitment of at
least seven years; longer is even better. Once you are committed to the long
term, the ups and downs of the market won’t get to you as much, because you
will recognize that they are just part of the deal. Warren Buffett, the most
successful and best-known investor in the U.S. (No. 4 in 2014 World’s Richest,
$58.2 Billion), says that for him a flip (the time frame for buying and then
selling a stock) is five years, meaning that five years is the minimum amount
of time that he’ll hold on to a given stock. Long-term investing is a
commitment, and commitments, as we all know, require patience and endurance.
The biggest risk in investing is doing nothing and watching inflation eat up
your money. Even at the low inflation rate of 3% per annum, you lose more than
a third of your money’s purchasing power every ten years.
Investment planning in the context of a
personal financial plan is not limited to investment selection, its ultimate
objective is to grow your funds by investing it in an appropriate manner so
that you would be able to realize most of your financial goals. A practical
approach that can help in coming out with a sensible personal investment plan
involves answering three questions: (1) Where are you now? (2) Where do you
want to be? and (3) How will you get there? Assess your current financial
status. We cannot invest the money we don’t have. In determining personal
financial goals, it helps if we can articulate and quantify our financial goals
by setting financial milestones and timelines so we would know if we are on
track. Assuming we need P20 million to ensure a comfortable retirement, how
much savings should we realize every month to be invested for my retirement
goal. There are three factors to consider: (1) timeline, i.e. 20 years, (2)
amount of investment and (3) rate of return.
When
a person “invests,” he puts a portion of his disposable income in a vehicle
which in the long run – hopefully – appreciates in value faster than the
decline in his money’s buying power. He postpones the satisfaction he derives
from spending his money, expecting that in the future he will gain greater
satisfaction from its accelerated value. While we are productive, we should set
aside a portion of our income for the time we are no longer earning, but still
living. Whether you are on a fixed salary or in business, it is possible to
save/invest if you really want to. Setting aside 10% of the monthly income is
the general rule, but you can go higher or lower, depending on what you can
manage. Without a budget, the ability to save weakens, or worse, is lost. A
good rule, as with any other investment plan, is to use only your excess cash.
Investment
is viewed as delayed gratification. Apparently, your ability to delay
gratification in exchange for more and better rewards is an indication of
success. The main reason to invest is to achieve growth. But risk is an
inherent part of investments, and it is a major deterrent for anyone. Whether
it is bonds, stocks or money market/cash equivalents, an investor bears the
burden of loss during a market decline or economic recession.
Once
you have a firm grip on the basics – establishing a budget, maintaining an
emergency fund, getting sufficient insurance coverage – you can then began
exploring the world of investments. The sooner you start investing, the more
money you will accumulate to meet your goals. If your money is in a savings
account, you are not investing for your future. Investing is the only way you
will keep ahead of inflation.
However,
if you want to stay ahead of inflation and keep your portfolio growing, you
simply have to take some risks. Your investments should enable you to meet your
personal and financial goals. Before making a choice, you should also be
prepared to evaluate the following three factors, which are intrinsic to all
investments: (1) safety (2) liquidity (3) return. The last is the rate at which you can make money on your
investment. You should look for a return that outpaces inflation.
Investments
offer two kinds of return: growth and income. Capital growth results from increases in the market price of a security.
Common stocks are probably the best-known growth investment. Income investments, on the other hand,
provide current cash payments in the form of interest and dividends. Bonds,
mortgage-backed securities, and CDs are examples of income investments.
The old adage, “Don’t put all your eggs in one
basket” is probably the best investment advice for everyone. Put your money
into different investments – those that differ by industry, time period, and
the rate of return. This is what diversification
means: you are spreading out your risk by selecting several investments.
Initially, in investing money, you can start off with a modest sum of money –
whatever is left after you have paid your monthly bills and kept up your
emergency fund.
Before
you invest, make sure you have created a financial safety net that consists of
the basic necessities:
1.
Set
aside for emergency funds.
Set aside perhaps two months’ living expenses and put them in a place where you
can access them quickly and easily – in the event of illness or a period of
unemployment. Keep these funds liquid – an investment that can be converted to
cash. Too often, people tie up money that should be available for emergencies
or for the purchase of a new car or some other predictable expense. If you
invest what should be emergency funds in stocks, you may be forced into selling
stocks at a time not of your own choosing.
2.
Make
sure you are adequately insured. Insurance is an important part of your overall
financial plan. If you have dependents, health and life insurance are crucial.
Life insurance is the best hedge against that ultimate crisis, the death of the
primary supporter.
3.
Contribute
the maximum amount to a savings account. Regularly investing in that account is the
best long-term investment you can make. One way to make sure you contribute
regularly is to “pay yourself first” by signing up for an automatic investment
plan which allows regular investments to be made through payroll deduction or
through automatic transfers from your account. Try to start with at least 5% to
10% of your gross (the total amount you earn before taxes), and increase that
amount if you are able to comfortably. Use that money to invest for your
future.
Every
investment is associated with a certain amount of risk. You can control the
level of risk in the investment you choose. You have to know yourself. Once you
know what kind of investor you are, you will have a clearer idea of what types
of investment to choose.
In general terms, investments fall
into three categories:
1.
Stocks - Stocks
are sometimes called equities. (see
discussion about stocks)
2.
Bonds
A bond fall under a category of
investments known as “debt investments.” A bond is a security issued by a
corporation, a government or its agency that is in need of money and is willing
to go into debt to borrow that money to meet its needs. When you lend any of
these entities your money, you have purchased what is known as a bond. Basically,
a bond is nothing more than an IOU. You are the lender, and the issuer of the
bond is the debtor.
3.
Cash Equivalents
Cash-equivalent
investments are investments that you can easily convert into cash, like money
market funds, Treasury bills, and Certificate of Deposits. They are sometimes
called as fixed-income instruments, give a fixed rate of return within a
specified amount of time. Essentially, they are like stocks in that they
provide capital for the company. However, those who buy stocks are considered
shareholders or part-owners of the company, while those who invest in
fixed-income products are considered as debtors. Treasury bills (T-bills) are
actually one of the safest places to put your money. This fixed-income
investment is virtually risk-free. The private sector also issues fixed-income
investment instruments as proof of indebtedness. Corporations, especially the
large ones, sell short and long-term commercial papers (CPs) to the public.
Short-term CPs have maturity periods of one year or less. Their interest rates
are determined monthly or as agreed upon by the issuing company and the selling
agent. Long-term CPs often command higher interest yields as these are based on
the prevailing 91-day T-Bill rates plus the agent’s mark-up. Premiums on the
CPs depend on the financial standing of the issuing company. Another form of
fixed-income investment offered by private firms are promissory notes (PNs).
They are much like CPs except that the former are not subject to withholding
tax.
The
most common fixed-income instrument is the bank time deposit. It is the easiest
to invest in as it requires smaller investment amounts. The longer you keep
your money in the bank, the greater the interest you will earn on your deposit.
Your money’s number one enemy is
inflation. It does not seem real to most consumers. But here is an illustration
of what inflation is. For the last 10 years, inflation averaged about 10.5%.
Sixteen years ago, an 8 oz. bottle of Coke cost P2.00. Now, you have to pay P7.00,
which is more than triple its price. That is inflation. To protect yourself
from inflation, you need to make money from your money. Thus, protection
against inflation is compound interest. Compound
interest is interest on interest, as opposed to, simple interest which is just
principal plus interest, over a certain period. It is better to put it in an
account that compounds, rather than an account that just uses simple interest.
The magic of compound interest really comes into effect when you are investing
or saving for a longer period of time. The longer the period gets, the stronger
the magic gets. Basically, to beat inflation you have to make your money work
harder for you, by investing it in something with a higher rate than inflation.
An inflation risk is the possibility
that increased inflation – an increase in the cost of living – will reduce or
eliminate a specific investment’s returns.
The
power of compounding is one of the most compelling reasons for investing as
soon as possible. Money that is compounding grows remarkably fast. For example,
P10,000 invested for 20 years at an 8% rate of return would grow to over
P45,000. The same P10,000 invested at 12% would grow to over P96,000 in 20
years. The rule of 72 comes in handy when you are talking about time and
money. This simple formula gives you an approximate idea of how long it will
take to double your money at different rates of return. Suppose you want to
know how long it will take to double your investment at 8%. Simply divide the
number 72 by your rate of return. At an 8% rate of return, doubling your money
will take 9 years (72/8 = 9). At a 10% rate of return, it will take 7.2 years
to double your money (72/10 = 7.2) And so on and so forth.
Reference:
- Robert T. Kiyosaki - Rich Dad, Poor Dad, Warner Books, Inc., New York, NY, 1998.
- Debra Wishik Englander – How to Be Your Own Financial Planner, Prima Publishing, Rocklin, CA, USA, 1996.
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