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

• 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,

• 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,

• 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.

The 4 major asset classes: the building blocks of any investment plan

Any serious investor should have a basic knowledge of the 4 major asset classes and the risk inherent in each:

• Cash - low risk  (For Savings and Protection)
• Bonds - moderate risk (For Income)
• Property - moderate to high risk (For Growth and Income)
• Equities - high risk (For Growth)

Remember this fundamental rule:

The bigger the risk you take, the greater the possible reward or return (growth on capital) you can expect.

The safer your investment and the smaller the risk you take, the smaller the possibility of a great return.

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

• invest in dubious or risky products, or
• know too little about themselves and the product or asset classes in which they invest.

What money means to you? Answer 10 simple questions.

In order to really make your money work for you, it is important to try and get

• to know more about yourself and
• your relationship with money. 

Some "money psychology" should help you to deal with your financial affairs in a smart way.

To find out more about your investment orientation and your relationship with money, answer the 10 simple questions below as honestly as possible.  This will also help set the necessary guidelines for your investment portfolio.

Time horizon
Questions 1 - 5

Risk tolerance
Questions 6 - 8

Investment Objectives
Questions 9 - 10

http://spreadsheets.google.com/pub?key=tr9oMvjAsDJvkcPgXdd763A&output=html


Your total score tells you more about yourself.

Less than 10:  You cannot afford to make mistakes
Between 10 and 20:  You are carefully weighing up your options.
More than 20:  You want to grow bigger and better.

Investment Objectives

There are four major financial phases in life:

• a no-strings-attached youth,
• building a family,
• working towards retirement, and,
• retirement itself.

Each depends on how you view

• your lifestyle,
• your financial situation and
• your investment objectives. 

Identify where you are in the cycle and how it affects your financial goals.

Risk Tolerance

Time is not the only factor that affects the risk you take when you invest.

Your own tolerance of risk is an important factor.

Risk is the measurement of your willingness to see your investments shrink in the short-term, even though you know they will increase in the longer term. 

You need to have some idea of your level of risk tolerance.

Time Horizon

What are your major deadlines in life?

 How much time do you have to save and invest before you retire?

Your time horizon is very important when you invest, because compounding works best over a longer period. 

Time and risk are also related. 

If you are young and have many working years ahead of you, you can afford to take bigger risks with your investments than an older person close to retirement.

Be realistic: adjust your investment objectives to fit in with your time horizon and risk tolerance level.

You also have to realise that you need to align your time horizon, risk tolerance and investment objectives. 

You might have a very short time horizon before retirement and a low risk tolerance, you might want to see significant capital growth. 

It is important to be realistic:  you have to adjust your investment objectives to fit in with your time horizon and risk tolerance level.

This also means you will have to find a balance between the risk you are prepared to take and your preferred returns.  Risk and reward are always at opposite end of the scale - the higher the risk, the higher the potential return, and the lower the risk, the lower the expected return.

Therefore, the importance of you knowing more about who you are and how you want your money to work for you at this stage in your life. 

The Aim of Almost Every Investor

The aim of almost every investor is to obtain a combination of safety, income and capital growth. 

Sir John Templeton

The January Effect

Dow is down 3% in January 2010.

Do you believe in the January effect?  I don't.

Three most important personal factors to consider: Your Time Horizon, Risk Tolerance and Investment Objectives

How well do you know yourself

In understanding your relationship with money, what are the 3 most important personal factors to consider?

These are:

1. how long or short a time you have to invest
2. how much risk you can tolerate, and,
3. your investment objectives and whether they fit in with your time horizon and risk appetite.

Cash flow is another important factor to keep in mind when you assess your personal situation.  You need to have a good idea of your cash inflows and outflows and of how to do a balancing act between the two.  That is why a cash-flow needs analysis is such an important part of any financial advice programme.

By knowing more about yourself and where you want to be, you can now use this knowledge to construct an investment portfolio that fits your unique needs: 

• your time horizon,
• your risk tolerance and
• investment objectives. 

In short, you have created an investment portfolio tailor-made, so that your money can work for you.


Related:
Understand what money means to you:  Answer 10 simple questions
http://spreadsheets.google.com/pub?key=tr9oMvjAsDJvkcPgXdd763A&output=html

Asset Allocation:  The Best Way to Minimize Risk of Your Portfolio
http://myinvestingnotes.blogspot.com/2011/01/asset-allocation-best-way-to-minimize.html

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:

• 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.

Compounding: your ultimate friend

If inflation is your ultimate enemy, compounding is your ultimate friend.

Einstein even called it the eighth wonder of the world - and being the genius he was, he would have known!

Compounding is the best weapon in your arsenal, the one thing that can make your money grow, despite inflation.

Compounding simply means that the returns on the investment grow too, and not only the capital.  It is growth on growth, or interest on interest.

The longer you invest, the more your money will grow.  That is why time is important, and the earlier you start investing the more you will earn.

Delaying your investments is as bad as not investing at all.

Example of Ann and Peter, two young people.

Ann saves $500 a year.  She starts when she is 15 years old and invests in the stock market for 10 years at a return of 20% a year. After 10 years she stops adding money to her nest egg.

Her friend, Peter, only starts to save when he is 40 years old.  After initially squandering his income rashly, Peter starts saving $40,000 a year for 25 years, also at a return of 20%.

Who do you think has the most money at retirement?

• The total amount of $5000 that Ann had saved over 10 years, gave her a grand total of $22.9 million at the age of 65.
• Peter on the other hand, battled to save a total of $1 million and ended up with $22.7 million.

Neither of them will have any financial problems, but the point is that Ann's money grew for 50 years - twice as long as Peter's did, and with much less effort.

How did Ann achieve this?  Not because of:

• the rate of return:  both earned the same return on their investment, nor
• the capital she put in:  Peter put in far more.

But because of:

• the time factor.  Over time, Ann had growth on her money and on her returns.  Compounding is a winning recipe.

Inflation: your ultimate enemy

Inflation erodes your money systematically. 

Inflation simply means that prices of goods and services go up, so the purchasing power of your money decreases and you have to pay more to maintain the lifestyle to which you have become accustomed. 

For example, your pension may seem to be adequate now, while you are saving for it.  However, after a number of years' retirement, you may suddenly realise that the amount you had set aside is not enough and you cannot maintain your standard of living.  With life expectancy on the increase, people often outlive their money.

Even in the current relatively low-inflation environment, inflation can make a big difference in your retirement. 

For example:  if you hid $1,000 under your mattress today and left it there for 20 years, even at a fairly low inflation rate of 3%, it would have shrunk to the equivalent of $544 - almost half its original value.

So inflation eats away at your money.  It has no regard for how hard you have worked, how many hours you have put in or even how efficient you are.  Your money simply becomes worth less as time goes by.

Your money's job description and your principal financial goal: "Work to give a real rate of return."

Return is a very important concept in the investment world.  It is simply the difference between the money you start off with and the money you end up with.  In other words, how your money has grown. 

The rate of return is the pace at which you achieve that growth, and is normally expressed as a percentage per year. 

The nominal rate of return does not take inflation into account, while the real rate of return is the nominal rate of return less the inflation rate.

E.g.

Nominal rate of return for FD 4%
Inflation 3%
Real rate of return for FD 1% (4% - 3%)

You should learn how your money can work for you to increase over time and to beat inflation.

Your money should give you a real rate of return.  This should be your money's job description and your principal financial goal.

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:

• 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.