Showing posts with label financial education. Show all posts
Showing posts with label financial education. Show all posts
Sunday 31 January 2010
Congratulations, You're an Investor!
Congratulations, You're an Investor!
By Dayana Yochim
January 29, 2010
During this monthlong Fiscal Fitness Boot Camp, we worked some money magic -- saving big bucks by scrutinizing our major (and even some minor) expenses.
What's the point? Sure, padding the bank account is good. Freeing up cash to more quickly pay down high-interest debt is even better.
But once the basics are taken care of -- once that debt is but a distant memory, and you've got a decent emergency cash cushion for life's just-in-case events -- the very best thing you can do with your money is to make it grow. In other words: You've mastered the art of saving. Now it's time to become a bona-fide investor.
Channel your inner Warren Buffett
The truth is that every one of us is already an investor. Every dollar decision we make is an investment, whether for long-term gain (retirement savings), short-term safety (emergency fund), or immediate pleasure (mocha latte -- hey, I'm not one to judge). (This mind-set -- "Treat Every Dollar as an Investment" -- is such an important part of successful money management that we've made it a key part of our Motley Fool Magna Carta.)
However, today we're going to venture into the world of traditional investing. If you complete today's homework, you'll snag the most handsome payoff of this entire series -- adding tens of thousands of dollars to your bottom line.
Don't start mentally spending that money just yet. Investing is a long-term exercise. The kind of savings we're talking about will accumulate over years -- decades, even. But it's not going to happen magically on its own. So let's get started.
Your first investment
As scary as the stock market has been as of late, it's still the best place for your long-term savings. (Note the emphasis on long-term. We're talking about money you do not need to touch for five to 10 years, depending on your tolerance for risk.) With that in mind, when it comes to traditional investing -- as in IRAs, 401(k)s, stocks, bonds, mutual funds, gold doubloons -- start with the basics and you're 90% of the way there.
Last year, we recommended three stocks -- Costco (Nasdaq: COST), Paychex (Nasdaq: PAYX), and National Oilwell Varco (NYSE: NOV) -- to our Fiscal Fitness graduates. But if you don't want to jump into individual stocks, that doesn't mean you shouldn't invest.
One of the easiest ways to get started investing is to sign up for a 401(k), 403(b), or 457 plan at work, if your employer offers one. The money is deducted from your paycheck and sent straight to your 401(k), 403(b), or 457, before income taxes are taken out.
Another reason to do so? Free money! Many employers add money to your account based on the amount that you sock away. Incredibly, however, many people don't take their employers up on the offer. That's essentially dissing an instant, guaranteed return on their money. For example, save $5,000 with a 25% employer match, and you suddenly have $6,250. (Whatever you do, don't make one of these six common 401(k) blunders!)
Once you've maxed out your 401(k) -- or if you don't have one at your place of employment -- it's time to move on to phase 2 of building a portfolio.
How to invest $50, $500, and $5,000-plus
First, determine how much you have to invest. Depending on how much money you've freed up to invest, some investment battle plans make more sense than others. Here's advice on how to proceed with $50, $500, and $5,000-plus.
How to invest $50:Thanks to the miracle of compound interest, even small sums can add up to big nest eggs over time. (Get a load of these charts to see what I mean.) If you're just starting out, the very best thing you can do is to commit to investing on a regular basis.
One of the best ways to invest small amounts of money regularly and cheaply is through a DRP -- dividend reinvestment plans. They and their cousins, direct stock purchase plans (DSPs), allow you to bypass brokers (and their commissions) by buying stock directly from the companies or their agents. They also allow you to reinvest dividends directly into more shares of stock. More than 1,000 major corporations offer these types of stock plans, many of them with fees low enough (or free) to make it worthwhile to invest as little as $50 at a time. Some plans even allow investments of as little as $20. Once you're in the plan, you can set up an automatic payment plan, and you don't even have to buy a full share each time you make a contribution.
What to do with $500: With this amount of money your investment options open up. You've got enough money to meet many companies' minimum initial investment requirement to open an IRA (or even a taxable brokerage account). (Here are 10 ways to size up a broker.)
Mutual funds are a popular investment option for many investors. You'll want to consider whether to go with an index fund, which simply tracks a particular benchmark, or an actively managed fund. You may want to start with a large-cap-oriented fund, which will give you exposure to well-known companies like ExxonMobil (NYSE: XOM), AT&T (NYSE: T), and Procter & Gamble (NYSE: PG). But you can also buy funds in just about any category, from bonds and small-cap stocks to shares of international companies like Vale (NYSE: VALE).
Some funds require as little as $250 for you to invest (typically restricted to IRAs). After your initial investment, you can add as much money as you like, as frequently as you like -- and if you choose a no-load fund and purchase directly from the fund company, there won't be any commissions. For beginners, a high-quality mutual fund is a great portfolio building block.
How to manage a $5,000-plus portfolio: As you establish a decent-sized retirement kitty (yay, you!), diversification should be your aim. You want to spread your money around -- allocate your assets -- owning both mutual funds and stocks to cushion yourself from stock market belly flops. (Here's the Fool's rules for asset allocation, including a handy chart that'll help you determine how much of your money should be invested in stocks.)
At this savings level, again, the power of making regular investments over time is very strong.
If you start with $1,000 at age 25 and invest an additional $1,000 each year, and your money earns 10% annually, then when you're ready to retire at age 65, you'll have more than $500,000 set aside. Yup. The key is to make sure that your costs of investing (including brokerage commissions, mutual fund management fees, etc.) add up to less than 2% of your account's overall worth. That's money that you've worked hard to save -- so make sure it's not slipping away in dribs and drabs!
Finally, let's end with the secret to investment success ...
Save more and invest more
End of story. Sounds dull, but if you get serious about those two things, you will turn your entire financial future around.
Let's say your Fiscal Fitness Boot Camp frees up 3% of your salary to invest this year. If you sock away $1,500 (3% of a $50,000 salary) and earn an 8% average annual return over five years (for a grand total of around $2,200), you'll bank $700 more than if you hadn't become an investor. Commit to the 3% savings goal for the next five years (for a total of $7,500 invested), and your portfolio will blossom to more than $11,000 -- that's an extra $3,500 in nest egg padding.
What's the point?
At the beginning of this article, I asked, "What's the point?" The example above just puts a dollar figure on the benefits of investing.
But the real point of this entire exercise is what that money represents.
So what's the point of saving and investing for you? Do share in the comments area below.
http://www.fool.com/investing/general/2010/01/29/congratulations-youre-an-investor.aspx
By Dayana Yochim
January 29, 2010
During this monthlong Fiscal Fitness Boot Camp, we worked some money magic -- saving big bucks by scrutinizing our major (and even some minor) expenses.
What's the point? Sure, padding the bank account is good. Freeing up cash to more quickly pay down high-interest debt is even better.
But once the basics are taken care of -- once that debt is but a distant memory, and you've got a decent emergency cash cushion for life's just-in-case events -- the very best thing you can do with your money is to make it grow. In other words: You've mastered the art of saving. Now it's time to become a bona-fide investor.
Channel your inner Warren Buffett
The truth is that every one of us is already an investor. Every dollar decision we make is an investment, whether for long-term gain (retirement savings), short-term safety (emergency fund), or immediate pleasure (mocha latte -- hey, I'm not one to judge). (This mind-set -- "Treat Every Dollar as an Investment" -- is such an important part of successful money management that we've made it a key part of our Motley Fool Magna Carta.)
However, today we're going to venture into the world of traditional investing. If you complete today's homework, you'll snag the most handsome payoff of this entire series -- adding tens of thousands of dollars to your bottom line.
Don't start mentally spending that money just yet. Investing is a long-term exercise. The kind of savings we're talking about will accumulate over years -- decades, even. But it's not going to happen magically on its own. So let's get started.
Your first investment
As scary as the stock market has been as of late, it's still the best place for your long-term savings. (Note the emphasis on long-term. We're talking about money you do not need to touch for five to 10 years, depending on your tolerance for risk.) With that in mind, when it comes to traditional investing -- as in IRAs, 401(k)s, stocks, bonds, mutual funds, gold doubloons -- start with the basics and you're 90% of the way there.
Last year, we recommended three stocks -- Costco (Nasdaq: COST), Paychex (Nasdaq: PAYX), and National Oilwell Varco (NYSE: NOV) -- to our Fiscal Fitness graduates. But if you don't want to jump into individual stocks, that doesn't mean you shouldn't invest.
One of the easiest ways to get started investing is to sign up for a 401(k), 403(b), or 457 plan at work, if your employer offers one. The money is deducted from your paycheck and sent straight to your 401(k), 403(b), or 457, before income taxes are taken out.
Another reason to do so? Free money! Many employers add money to your account based on the amount that you sock away. Incredibly, however, many people don't take their employers up on the offer. That's essentially dissing an instant, guaranteed return on their money. For example, save $5,000 with a 25% employer match, and you suddenly have $6,250. (Whatever you do, don't make one of these six common 401(k) blunders!)
Once you've maxed out your 401(k) -- or if you don't have one at your place of employment -- it's time to move on to phase 2 of building a portfolio.
How to invest $50, $500, and $5,000-plus
First, determine how much you have to invest. Depending on how much money you've freed up to invest, some investment battle plans make more sense than others. Here's advice on how to proceed with $50, $500, and $5,000-plus.
How to invest $50:Thanks to the miracle of compound interest, even small sums can add up to big nest eggs over time. (Get a load of these charts to see what I mean.) If you're just starting out, the very best thing you can do is to commit to investing on a regular basis.
One of the best ways to invest small amounts of money regularly and cheaply is through a DRP -- dividend reinvestment plans. They and their cousins, direct stock purchase plans (DSPs), allow you to bypass brokers (and their commissions) by buying stock directly from the companies or their agents. They also allow you to reinvest dividends directly into more shares of stock. More than 1,000 major corporations offer these types of stock plans, many of them with fees low enough (or free) to make it worthwhile to invest as little as $50 at a time. Some plans even allow investments of as little as $20. Once you're in the plan, you can set up an automatic payment plan, and you don't even have to buy a full share each time you make a contribution.
What to do with $500: With this amount of money your investment options open up. You've got enough money to meet many companies' minimum initial investment requirement to open an IRA (or even a taxable brokerage account). (Here are 10 ways to size up a broker.)
Mutual funds are a popular investment option for many investors. You'll want to consider whether to go with an index fund, which simply tracks a particular benchmark, or an actively managed fund. You may want to start with a large-cap-oriented fund, which will give you exposure to well-known companies like ExxonMobil (NYSE: XOM), AT&T (NYSE: T), and Procter & Gamble (NYSE: PG). But you can also buy funds in just about any category, from bonds and small-cap stocks to shares of international companies like Vale (NYSE: VALE).
Some funds require as little as $250 for you to invest (typically restricted to IRAs). After your initial investment, you can add as much money as you like, as frequently as you like -- and if you choose a no-load fund and purchase directly from the fund company, there won't be any commissions. For beginners, a high-quality mutual fund is a great portfolio building block.
How to manage a $5,000-plus portfolio: As you establish a decent-sized retirement kitty (yay, you!), diversification should be your aim. You want to spread your money around -- allocate your assets -- owning both mutual funds and stocks to cushion yourself from stock market belly flops. (Here's the Fool's rules for asset allocation, including a handy chart that'll help you determine how much of your money should be invested in stocks.)
At this savings level, again, the power of making regular investments over time is very strong.
If you start with $1,000 at age 25 and invest an additional $1,000 each year, and your money earns 10% annually, then when you're ready to retire at age 65, you'll have more than $500,000 set aside. Yup. The key is to make sure that your costs of investing (including brokerage commissions, mutual fund management fees, etc.) add up to less than 2% of your account's overall worth. That's money that you've worked hard to save -- so make sure it's not slipping away in dribs and drabs!
Finally, let's end with the secret to investment success ...
Save more and invest more
End of story. Sounds dull, but if you get serious about those two things, you will turn your entire financial future around.
Let's say your Fiscal Fitness Boot Camp frees up 3% of your salary to invest this year. If you sock away $1,500 (3% of a $50,000 salary) and earn an 8% average annual return over five years (for a grand total of around $2,200), you'll bank $700 more than if you hadn't become an investor. Commit to the 3% savings goal for the next five years (for a total of $7,500 invested), and your portfolio will blossom to more than $11,000 -- that's an extra $3,500 in nest egg padding.
What's the point?
At the beginning of this article, I asked, "What's the point?" The example above just puts a dollar figure on the benefits of investing.
But the real point of this entire exercise is what that money represents.
- For some of you, the savings we've found during this month means freedom from the shackles of debt.
- For others, it means peace of mind, being financially prepared should you lose your job or if the water heater goes on the fritz.
- And for a few folks out there, this month of becoming fiscally aware will pave the way to an early retirement, the ability to put a down payment on a house in 10 years, or even just a sense of control and stability that you've never felt before.
So what's the point of saving and investing for you? Do share in the comments area below.
http://www.fool.com/investing/general/2010/01/29/congratulations-youre-an-investor.aspx
Reviewing the basics of interest-bearing investments
To have a good understanding of interest-bearing investments, learn and know the followings.
The risks of interest-bearing investments, for example:
The advantages of investing in this asset class, particularly
Some of the main interest-bearing investments in the market. These include:
You have to know about two new market places other than the stock market:
The risks of interest-bearing investments, for example:
- inflation,
- interest rate cycles and
- dubious borrowers with poor credit ratings.
The advantages of investing in this asset class, particularly
- the interest income on which you can rely.
Some of the main interest-bearing investments in the market. These include:
- cash,
- money market funds,
- bonds,
- participation mortgage bonds and
- voluntary purchased term annuities.
You have to know about two new market places other than the stock market:
- the money market, where short-term interest-bearing secuities are traded, and
- the bond market, where longer-term interest-bearing securites such as bonds are traded.
Mistakes to avoid when investing in interest-bearing instruments
Interest-bearing investments may be relatively stress-free, but they too have their pitfalls. Watch out for the following:
- Do not accept the first interest rate you are offered. Compare interest rates, negotiate where possible and find out more about fixed versus fluctuating interest rates and the term of fixed-interest investments.
- Do not think interest-bearing investments are safe, risk-free havens. Remember the impact of inflation.
- Do not forget about interest rate risk. When interest rates increase, bond prices will decrease, resulting in a loss on your investment. The longer the term of the bonds, the greater the drop in the market price.
- Do not invest in bonds without understanding the terms of the bonds and the interest rate environment. Invest in well-known and reputable bonds rather than in unknown corporate bonds.
Other interesting interest-bearing investments: Mortgage Bonds and Term Annuities
Today a myriad of unit trusts invest in interest-bearing investments. These include:
Mortgage Bonds
One of the most attractive interest-bearing investments with a fixed capital value is participation mortgage bonds.
Term Annuity
A voluntary purchased term annuity is another important investment product from which you can earn a regular income. It is simply the exchange of a cash lump sum for income, which is paid annually, half-yearly, quarterly or in monthly instalments over a specified period (minimum five years).
- money market funds,
- income funds, and,
- bond funds.
Mortgage Bonds
One of the most attractive interest-bearing investments with a fixed capital value is participation mortgage bonds.
- Here you invest in units in large mortgage loans that are granted against the security of a first-class physical asset, for example, commercial, industrial or other property.
- Your capital is guaranteed and you earn interest at a competitive rate that can be variable or fixed.
- A great advantge is that a participation bond becomes quite liquid after the initial five-year period when you can still enjoy the interest income and withdraw on only three months' notice.
- (These mortgage bonds caused the subprime credit crisis in 2007-2008 in US).
Term Annuity
A voluntary purchased term annuity is another important investment product from which you can earn a regular income. It is simply the exchange of a cash lump sum for income, which is paid annually, half-yearly, quarterly or in monthly instalments over a specified period (minimum five years).
- This basically means that your original capital is refunded by way of regular instalments together with interest earned on the investment.
- You will therefore not get back any capital at the end of the period as in the case of fixed deposit.
- A voluntary term annuity can be purchased at any life office and is in essence an insurance contract.
- The interest or annuity rate is fixed for the term of the contract, but varies from institution to institution.
- This investment product also offers a tax benefit, as you pay tax only on the interest part of your annuity.
More about another interest bearing investments: bonds
Bonds are fixed-income securities that governments and companies issue in order to borrow money. They pay interest to you for that privilege.
The maturity date is the date on which the full amount that was borrowed is returned to you .
The investment term is normally a fairly long period, say ten years or longer.
The coupon is the interest rate you receive.
Bonds are traded on the capital market in the same way that equities are traded on the stock market.
Bonds are medium-risk investments because the interest rate cycle has a definite impact on the value of bonds.
If you want to understand bonds, this is the most important thing to remember: when interest rates fall, bond prices rise; when interest rates rise, bond prices fall.
This is simply because the coupon on the bond is fixed, and the market value of the bond is adjusted to bring the coupon in line with the external interest rate.
Bonds are a very important part of a well-diversified portfolio. In difficult stock markets, bonds can provide a cushion to soften the blow.
The maturity date is the date on which the full amount that was borrowed is returned to you .
The investment term is normally a fairly long period, say ten years or longer.
The coupon is the interest rate you receive.
Bonds are traded on the capital market in the same way that equities are traded on the stock market.
Bonds are medium-risk investments because the interest rate cycle has a definite impact on the value of bonds.
If you want to understand bonds, this is the most important thing to remember: when interest rates fall, bond prices rise; when interest rates rise, bond prices fall.
This is simply because the coupon on the bond is fixed, and the market value of the bond is adjusted to bring the coupon in line with the external interest rate.
Bonds are a very important part of a well-diversified portfolio. In difficult stock markets, bonds can provide a cushion to soften the blow.
Money market funds have become very popular alternative to bank deposit
A money market fund is a type of unit trust that invests in interest-bearing instruments issued by banks, government and companies when they want to borrow money.
These short-term instruments are
Money market funds have major advantages in comparison with other cash investments. For example:
This income is capitalised, or reinvested, which means the investor earns interest on interest.
Money market funds are ideal
When you invest in a money market acount, you should know the difference between the nominal and effective rate.
These short-term instruments are
- traded on the money market, and
- have a maturity of less than 12 months.
Money market funds have major advantages in comparison with other cash investments. For example:
- You gain access to money market instruments even though you invest only a small amount.
- The interest rate is higher than for a bank deposit, as you are part of a group that can bargain for the best wholesale rates.
- You can withdraw your money at any time, like a call deposit at a bank.
- Interest rate risk is largely eliminated because money market funds are allowed to invest only in instruments with an average term of not more than 90 days.
This income is capitalised, or reinvested, which means the investor earns interest on interest.
Money market funds are ideal
- for pensioners who must live on their interest income or
- for the creation of an emergency fund from which you can withdraw money at any time.
- to limit the risk of an investment portfolio in uncertain times or
- to phase in their funds.
When you invest in a money market acount, you should know the difference between the nominal and effective rate.
- The effective rate is the interest rate you will earn if your money is deposited for the whole year and all the interest is reinvested.
- The nominal rate is lower because this is the rate you earn every month before any reinvestment of interest is taken into account.
The 'safe' option of cash
Cash has always been seen as a fairly safe investment, and our forefathers were quite happy to put their money under the mattress and leave it there.
Today we realise that you cannot just put your money away and forget about it, because inflation will erode its value.
If you want a stable income, a bank deposit is still a valuable investment option.
However, money market funds have become a very popular alternative.
Today we realise that you cannot just put your money away and forget about it, because inflation will erode its value.
If you want a stable income, a bank deposit is still a valuable investment option.
However, money market funds have become a very popular alternative.
Saturday 30 January 2010
The calmer waters of interest-bearing investments: their risks and rewards
The interest-bearing investments include:
The focus of interest-bearing investments is not on the appreciation (increase) of the capital you have invested, but rather on the provision of a steady interest income - often at a fixed rate.
While shares offer you higher returns at a higher risk, interest-bearing investments offer you lower returns at a lower risk, making them a safe haven for many investors.
But this safe asset class is not safe from inflation.
Interest-bearing investments often do not generate the kind of return that beats inflation, and it is very important to remember that interest income is taxable. After taking tax into account, the return on interest-bearing investments often struggles to beat the inflation rate.
The reason for this is simple. Interest-bearing investments are normally money you lend to a bank, government, company or other institution with the undertaking that this exact amount will be paid back after a period of time.
In return for this, you earn interest.
Since you only get the same amount back after a couple of months or years, that amount is usually worth less as a result of inflation.
Your only real benefit is the income that you receive.
Interest-bearing investments also hold other risks.
Interest-bearing investments do, however, play an important part in an investment portfolio. Although inflation will still erode the capital value of your investment, these investments do have advantages, including:
- cash
- bonds
- the money market securities.
The focus of interest-bearing investments is not on the appreciation (increase) of the capital you have invested, but rather on the provision of a steady interest income - often at a fixed rate.
While shares offer you higher returns at a higher risk, interest-bearing investments offer you lower returns at a lower risk, making them a safe haven for many investors.
But this safe asset class is not safe from inflation.
Interest-bearing investments often do not generate the kind of return that beats inflation, and it is very important to remember that interest income is taxable. After taking tax into account, the return on interest-bearing investments often struggles to beat the inflation rate.
The reason for this is simple. Interest-bearing investments are normally money you lend to a bank, government, company or other institution with the undertaking that this exact amount will be paid back after a period of time.
In return for this, you earn interest.
Since you only get the same amount back after a couple of months or years, that amount is usually worth less as a result of inflation.
Your only real benefit is the income that you receive.
Interest-bearing investments also hold other risks.
- This asset class is subject to the ups and downs of the interest rate cycle. As interest rates increase or decrease, your cash flow can be affected - unless you have a fixed interest rate.
- Furthermore, you should beware of institutions with credit risk. A high interest rate is not everything: you must also be sure that your capital will be paid back.
Interest-bearing investments do, however, play an important part in an investment portfolio. Although inflation will still erode the capital value of your investment, these investments do have advantages, including:
- offering you a relatively safe and predictable income.
- offering you less risk and volatility than an investment in equities
- offering diversification in your portfolio in case stock markets collapse
- giving you instant access to cash when you need it.
Investment in Property
Property is one of the main asset classes, the first investment most people make, and usually their biggest asset.
Investment in property offers the promise of
But you must also be aware that the capital value of your property can depreciate (or decrease) over time, therefore property is a medium- to high-risk investment.
One of the advantages of investment in property is gearing or leverage. This is the use of debt in the form of mortgage bond finance to 'leverage' you or help you to acquire an asset you would not otherwise be able to afford.
With a little financial help from your banking friends, you will, it is hoped, make a good capital gain on your investment one day.
There are different ways of investing in property.
Your own home
An own home is often the biggest asset in one's investment portfolio.
For most people, paying off their house takes up most of their earnings. They are using their mortgage bond to leverage them, possibly with the hope of making a capital gain one day.
Paying off a mortgage on your own home is one of the best investments you can make, and a golden rule to remember is that you should pay off your mortgage bond before you start thinking about investing in other asset classes.
As an own home can be a medium- to high-risk investment, you should be aware of the following dangers:
An investment portfolio of properties
Buying a property with a view to letting it and using the rental income to cover your mortgage bond payments (with the mortgage interest often tax-deductibe) while you benefit from the capital appreciation of the property sounds like a great investment strategy. So why do not more people do it?
The reason is perhaps because there are so many pitfalls in propety investment. Some of these are:
Property investing on the stock market
Property investing on the stock market gives the small investor the chance to invest in property in a more liquid way. You can sell your investment without having to sell a physical property, and you gain access to the propety expertise and scale benefits of large projects. There are three sectors in the stock market property division in which you can invest, namely:
These entities normally perform well in a falling interest rate environment, but, as with all property investments, are vulnerable to
Additional notes:
The concept of gearing: This can be explained by the following example. Say you have put down a deposit of $200,000 to buy a property of $1 million. Within two years, the property's value increases by 10% to $1.1 million. This means you have actually used $200,000 to earn $100,000 (i.e. 50% return) with the help of your bank manager!
Beware of property gains tax: This can reduce the attractiveness of investment property. Property gains tax can take a significant chunk of your capital gain when you sell property and will make it more difficult for this investment to beat inflation.
Investment in property offers the promise of
- an appreciation (or increase) in capital and
- a regular income in the form of rental payments.
But you must also be aware that the capital value of your property can depreciate (or decrease) over time, therefore property is a medium- to high-risk investment.
One of the advantages of investment in property is gearing or leverage. This is the use of debt in the form of mortgage bond finance to 'leverage' you or help you to acquire an asset you would not otherwise be able to afford.
With a little financial help from your banking friends, you will, it is hoped, make a good capital gain on your investment one day.
There are different ways of investing in property.
- On the one hand, you can simply own your own home in which you live.
- On the other hand, you can own an investment portfolio of different properites with a view to earning a rental income or capital profit from them.
- A third way to invest in property is through the stock market.
Your own home
An own home is often the biggest asset in one's investment portfolio.
For most people, paying off their house takes up most of their earnings. They are using their mortgage bond to leverage them, possibly with the hope of making a capital gain one day.
Paying off a mortgage on your own home is one of the best investments you can make, and a golden rule to remember is that you should pay off your mortgage bond before you start thinking about investing in other asset classes.
As an own home can be a medium- to high-risk investment, you should be aware of the following dangers:
- Property is highly illiquid. This means you do not have immediate access to the value of your property should you need cash (although you could use your mortgage bond facility), and if you decide to sell your house, there is no guarantee that you will be able to do so quickly.
- The value of your house is influenced by many factors over which you have no control, such as political factors and economic and interest rate cycles.
An investment portfolio of properties
Buying a property with a view to letting it and using the rental income to cover your mortgage bond payments (with the mortgage interest often tax-deductibe) while you benefit from the capital appreciation of the property sounds like a great investment strategy. So why do not more people do it?
The reason is perhaps because there are so many pitfalls in propety investment. Some of these are:
- Large amounts are required to invest in property.
- Properties need to be managed. Difficulties include problems with tenants, payments on time, maintenance, etc. and these must all be factored into your calculations.
- There is a high risk of bad timing in property investment. Certainly, you can make substantial capital gains, but only if you buy and sell the property at the right time.
Property investing on the stock market
Property investing on the stock market gives the small investor the chance to invest in property in a more liquid way. You can sell your investment without having to sell a physical property, and you gain access to the propety expertise and scale benefits of large projects. There are three sectors in the stock market property division in which you can invest, namely:
- property companies,
- property loan stocks, and
- property unit trusts or REITS
- the age,
- location and
- type of property in which it invests.
These entities normally perform well in a falling interest rate environment, but, as with all property investments, are vulnerable to
- interest rate cycles and
- economic and political change.
Additional notes:
The concept of gearing: This can be explained by the following example. Say you have put down a deposit of $200,000 to buy a property of $1 million. Within two years, the property's value increases by 10% to $1.1 million. This means you have actually used $200,000 to earn $100,000 (i.e. 50% return) with the help of your bank manager!
Beware of property gains tax: This can reduce the attractiveness of investment property. Property gains tax can take a significant chunk of your capital gain when you sell property and will make it more difficult for this investment to beat inflation.
Remember Diversification
Most investment plans should include a combination of the 4 major asset classes because of the benefit of diversification.
Diversification in this context means spreading your investment risk between the various asset classes. In other words, not putting all your eggs in one basket.
Investors who are prepared to hold a combination of equities, bonds and money market instruments stand a greater chance of higher returns over the long term than those who invest only in conservative investments such as cash.
By combining
Diversification in this context means spreading your investment risk between the various asset classes. In other words, not putting all your eggs in one basket.
Investors who are prepared to hold a combination of equities, bonds and money market instruments stand a greater chance of higher returns over the long term than those who invest only in conservative investments such as cash.
By combining
- the growth potential of equities with
- the higher income of bonds and
- the stability of money market funds,
- time horizon,
- risk tolerance profile and
- investment objectives.
Equities - high risk
An investment in equities (shares or stocks) means that you have obtained part-ownership in the company whose shares you have bought. Some companies are listed on a stock exchange, which means that your shares can be traded freely on that stock exchange.
Although equities are a high-risk asset class, they have the best chance of beating inflation over the longer term because of the inherent growth potential of the company in whch you have invested.
For that reason you should keep a SIGNIFICANT portion of your portfolio in equities. The basic rule is: the longer the time until you retire, the more you should invest in equities.
How do I know how much of my portfolio should be in equities?
Although equities are a high-risk asset class, they have the best chance of beating inflation over the longer term because of the inherent growth potential of the company in whch you have invested.
For that reason you should keep a SIGNIFICANT portion of your portfolio in equities. The basic rule is: the longer the time until you retire, the more you should invest in equities.
How do I know how much of my portfolio should be in equities?
- Try this general rule of thumb: multiply the number of years until you retire by two to get to the percentage of your assets that you should keep in equities.
- For instance, you are 45 years old and have 20 years before retirement. That means that you should invest 40% of your assets in equity.
Property - moderate to high risk
Property is often the biggest asset in a person's investment portfolio.
Property can keep up with inflation and can be a very effective way of gearing your investment.
This means that by using external financing you can increase the return on your investment. Debt in the form of a mortgage bond can help you to acquire an asset - and a return on this asset - you would not otherwise be able to afford.
The risk of property, however, is moderate to high.
Much depends on
One big drawback of this asset class is illiquidity: the fact that you cannot sell property as quickly as investments in other asset classes.
For that reason the safest option is to own your own home, but to leave property speculation (a potentially risky business) to the experts.
Property can keep up with inflation and can be a very effective way of gearing your investment.
This means that by using external financing you can increase the return on your investment. Debt in the form of a mortgage bond can help you to acquire an asset - and a return on this asset - you would not otherwise be able to afford.
The risk of property, however, is moderate to high.
Much depends on
- the location of the property and
- the political and economic environment.
One big drawback of this asset class is illiquidity: the fact that you cannot sell property as quickly as investments in other asset classes.
For that reason the safest option is to own your own home, but to leave property speculation (a potentially risky business) to the experts.
Bonds - moderate risk
Bonds or gilts can be defined as interest-bearing securities issued by governments or companies in order to borrow money.
In essence, it is an IOU, in which they promise to pay you, the lender,
This asset class offers a moderate risk.
In essence, it is an IOU, in which they promise to pay you, the lender,
- interest and
- to pay back your capital sum on a specific date.
This asset class offers a moderate risk.
- The capital sum that you invest can fluctuate, while
- the interest payments can be higher than on cash.
Cash - low risk
Cash is one investment from which you can never hope to make a fortune, althoug it can safeguard you against losing one.
Cash investments, including bank deposits and money market accounts,
But cash also carries risk. There is no guarantee that your capital sum will be protected against inflation, as this investment does not have any inherent growth potential.
Cash investments, including bank deposits and money market accounts,
- offer you the assurance of a regular interest income and
- knowing your capital will not be subjected to huge external fluctuations.
But cash also carries risk. There is no guarantee that your capital sum will be protected against inflation, as this investment does not have any inherent growth potential.
Why do so many people invest themselves into bankruptcy?
Investment is simply the saving of money with the aim of making it grow.
The amount you invest is called your capital. Investing is therefore the creation of more money through the use of capital.
The trick, of course, is finding the right assets in which to invest.
Why do so many people invest themselves into bankruptcy?
The answer is that they
The amount you invest is called your capital. Investing is therefore the creation of more money through the use of capital.
The trick, of course, is finding the right assets in which to invest.
Why do so many people invest themselves into bankruptcy?
The answer is that they
- invest in dubious or risky products, or
- know too little about themselves and the product or asset classes in which they invest.
Friday 29 January 2010
Reviewing the Financial Basics of Investment
- Long hours of back-breaking work do not guarantee financial independence.
- You need to work smarter with your money. Let your money work for you.
- This can be achieved by clever investing and the magic of compounding. This is the only way in which you can really beat your ultimate enemy, inflation, over the longer term.
A difficult environment - why invest? Take time out to try and understand the nuts and bolts of investment.
Compounding cannot take place without investment.
It is through clever investment that compounding makes your money work for you. The two are inextricably linked.
Investment is closely associated with the ups and downs of financial markets.
The last few years were particularly bad, as we saw the emerging markets crisis, the bursting of the internet bubble, then the terrorist attacks in the United States and the subsequent war taking their toll on investor sentiment, and the recent subprime credit crisis. Many investors have seen their wealth being eroded and have become disillusioned with investment in general.
Do not neglect your first priority
One of the big problems is that people think they should invest in equities (also called shares or stocks) despite the fact that they answer 'NO' to all the following three questions:
1. Can you comfortably cover your living expenses, including food and shelter?
2. Do you have enough cash for emergencies?
3. Do you have adequate insurance to protect your family?
The fact of the matter is that these items should be your first priority. It is only SURPLUS FUNDS that you should invest in the stock market.
The fluctuations of financial markets have not proven that investment is inherently bad. There is no other option if you want to combat inflation and increase the value of your savings over time. But political and economic crises do emphasise that:
Time passes all too quickly. Take time out to try and understand the nuts and bolts of investment. Do not allow yourself to run out of time. Read widely and in doing so, you will arm yourself with the knowledge needed to make your money work for you.
It is through clever investment that compounding makes your money work for you. The two are inextricably linked.
Investment is closely associated with the ups and downs of financial markets.
The last few years were particularly bad, as we saw the emerging markets crisis, the bursting of the internet bubble, then the terrorist attacks in the United States and the subsequent war taking their toll on investor sentiment, and the recent subprime credit crisis. Many investors have seen their wealth being eroded and have become disillusioned with investment in general.
Do not neglect your first priority
One of the big problems is that people think they should invest in equities (also called shares or stocks) despite the fact that they answer 'NO' to all the following three questions:
1. Can you comfortably cover your living expenses, including food and shelter?
2. Do you have enough cash for emergencies?
3. Do you have adequate insurance to protect your family?
The fact of the matter is that these items should be your first priority. It is only SURPLUS FUNDS that you should invest in the stock market.
The fluctuations of financial markets have not proven that investment is inherently bad. There is no other option if you want to combat inflation and increase the value of your savings over time. But political and economic crises do emphasise that:
- You should be clever about investing.
- You should know the investment basics.
- You should get serious about your money and retirement.
Time passes all too quickly. Take time out to try and understand the nuts and bolts of investment. Do not allow yourself to run out of time. Read widely and in doing so, you will arm yourself with the knowledge needed to make your money work for you.
A few sobering statistics. Only 6 out of 100 people achieve financial independence
It is estimated that out of every 100 people aged 25 today, in 40 years' time:
How many people of 60 and older do you know who are dependent on their family or still have to work? Scary, isn't it?
Many people do not realise that, despite their strong work ethic, their hard work alone is not enough to help them on their way to accumulating wealth and becoming financially independent.
To gain financial independence, your money must work for you. You need to be smart about money, and you need to know your money's enemies and friends.
The story of Rockefeller
As a teenager, John D. Rockefeller, one of the richest men in America in the 19th century, earned $1 hoeing potatoes for a neighbour for 30 hours. A week later, he collected interest of $3.50 on a loan he had made to another farmer a year earlier. Rockefeller learned early on that you do not necessarily need to work harder, but that you do need to work smart.
If you share Rockefeller's determination and want to end up being one of the 6 out of 100 people without financial worries when you retire, you should learn to invest early.
- only 6 will be financially independent
- 34 people will have passed away
- 10 will be drawing a government pension,
- 20 will still be working, and,
- 30 will be dependent on relatives.
How many people of 60 and older do you know who are dependent on their family or still have to work? Scary, isn't it?
Many people do not realise that, despite their strong work ethic, their hard work alone is not enough to help them on their way to accumulating wealth and becoming financially independent.
To gain financial independence, your money must work for you. You need to be smart about money, and you need to know your money's enemies and friends.
The story of Rockefeller
As a teenager, John D. Rockefeller, one of the richest men in America in the 19th century, earned $1 hoeing potatoes for a neighbour for 30 hours. A week later, he collected interest of $3.50 on a loan he had made to another farmer a year earlier. Rockefeller learned early on that you do not necessarily need to work harder, but that you do need to work smart.
If you share Rockefeller's determination and want to end up being one of the 6 out of 100 people without financial worries when you retire, you should learn to invest early.
Everyone wants to be financially independent
Acquiring investing knowledge is important. The earlier you acquire this knowledge of how your money can work for you, the better for you.
In order to gain financial independence you need to understand first and foremost that hard work is important, but not enough. You should also be clever about making the money you earn work hard for you.
You also need to know yourself before you make any investment decisions. Your objectives and the time you have in which to achieve them are the 2 most important factors when deciding on an investment programme.
Unfortunately, very few investors realise this when they start. You will need to find out how much risk you can tolerate, as well as what your relationship with money is.
Investment options are increasing dramatically in number and sophistication. Many people stumble along, buying a share here and a unit trust there. Only when they start learning about investments do they realise that they have made a mess of things. You have to make the most of this sophistication by adhering to simple principles and basic truths when compiling your investment portfolio.
The road may sometimes be bumpy, and at times you may wonder whether it would not have been more prudent to keep your hard-earned money under your mattress. But you will see that patience will be rewarded, and the ability to achieve long-term objectives depends on a long-term plan.
In order to gain financial independence you need to understand first and foremost that hard work is important, but not enough. You should also be clever about making the money you earn work hard for you.
You also need to know yourself before you make any investment decisions. Your objectives and the time you have in which to achieve them are the 2 most important factors when deciding on an investment programme.
Unfortunately, very few investors realise this when they start. You will need to find out how much risk you can tolerate, as well as what your relationship with money is.
Investment options are increasing dramatically in number and sophistication. Many people stumble along, buying a share here and a unit trust there. Only when they start learning about investments do they realise that they have made a mess of things. You have to make the most of this sophistication by adhering to simple principles and basic truths when compiling your investment portfolio.
The road may sometimes be bumpy, and at times you may wonder whether it would not have been more prudent to keep your hard-earned money under your mattress. But you will see that patience will be rewarded, and the ability to achieve long-term objectives depends on a long-term plan.
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