This article serves as a client education piece on financial planning and investing. Share it with your clients and use it to spark conversations about their financial goals.
At some point in your life, you’ll need money to buy your first home, build a college fund, prepare for retirement, or save for any other financial goals. If you do the number-crunching, you’ll likely discover that putting your money in a savings account alone wouldn’t be enough to achieve them.
The more viable option is to start investing your money in different assets like stocks and bonds, mutual funds, or perhaps even real estate. For beginners, investing can be intimidating and confusing, no thanks to the overwhelming choice of assets and information to sift through.
Fortunately, there are tried-and-tested approaches and basic principles that even the beginner investor can use. In this article, you can learn some fundamentals of smart investing and use this knowledge to secure a better financial future.
In simple terms, investing is the act of putting money to work for a specific time in a project or endeavour for the purpose of generating positive returns, usually in the form of profit. For this to be considered profit, the amount of returns must exceed the amount of the initial investment.
There are many different endeavours one can invest in directly or indirectly. This can include buying stocks and bonds at a low price, then selling at a higher price. Another example is buying property with the expectation of selling it for more later.
Don’t worry if you have no clue about investing – you're not alone! Here’s a video where random people share what they know about investing; this could give you some insight into what you should know too.
The video also offers also some important tips before you start investing, like how much of your salary to put into a savings account:
It’s important to know what sort of investments are available to you, so you can compare and decide which of them fit your needs like your risk tolerance (more on that later), budget, timeline, and financial goals.
The investments are listed here from least risky to most risky:
The most easily understood investment, cash deposited in a bank (usually in a savings account) is the safest investment. Depositing it in the bank gives investors the guarantee of fixed interest earnings and the return of their initial investment.
The main drawback to cash deposits in savings accounts is that they rarely beat inflation. An alternative that is almost like cash but earns at a higher interest rate is the Certificate of Deposit (CD). But for CDs to earn that much, the money must remain locked for a certain period, which can take a few months to several years. CDs can be withdrawn early, but there are penalties.
This is a debt instrument. Bonds are a representation of a loan made by an investor to a borrower.
Typically, a bond will be for money loaned to a corporation or government body. The borrower issues a fixed interest rate to their lenders for using their money. Bonds are often used by organizations to finance purchases, operational costs, or other projects.
How are bonds priced? As they are sold on the open market, they have three primary price influencers:
The price of a bond can be the face value (par value) or more or less than the face value. Prices can depend on the interest rate and the yield to maturity.
Mutual funds are a type of investment where investors pool their money to buy securities. This is a good investment for the beginning investor, since mutual funds are relatively easy to access. Some mutual funds require a low initial investment of $500, and others do not have a minimum investment at all.
In most cases, mutual funds are managed by professionals called fund managers or portfolio managers – but you can go DIY on mutual funds as well (not advisable for beginners). It’s the fund manager’s job to assemble a portfolio of different stocks, bonds, and other securities to provide their clients with the highest returns on their investments.
Mutual funds can be long-term or short-term investments; examples include equity funds and money market funds, respectively.
The mutual fund is a low-risk investment as it can be sometimes designed to imitate other indexes like the Dow Jones or S&P 500. It’s standard practice for mutual funds to be valued at the end of the trading day, with all transactions completed after the market closes.
This is a portfolio of stocks or bonds that imitate other existing financial market indices, like the S&P 500. As they follow a passive investment strategy, index funds can provide good returns since they also match the risk profile and returns of the market.
Index funds are based on the theory that the market as a whole can outperform any one investment in the long run. Compared to actively managed funds, index funds also incur lower expenses and fees, making this investment attractive to new investors.
Since they were first introduced in the 1990s, ETFs or Exchange-Traded Funds have gained a lot of popularity among investors. These are like mutual funds except they are traded throughout the day on a stock exchange. As they mimic the buy-and-sell nature of stocks, the value of ETFs can change dramatically all through the trading day.
Another similarity they share with mutual and index funds is that ETFs can also track an underlying index, such as the S&P 500. This allows ETFs to cobble together a portfolio with a lot of diversification, as with mutual funds.
ETFs are valued among investors due to their ease in trading and wide coverage.
Stocks are a type of security that represent the proportionate ownership of its holder in the issuing corporation’s equity and assets.
Stocks are like bonds in the sense that they are used to raise capital to fund operations, purchases, and other business activities. But instead of merely borrowing money from investors, corporations issue and sell these stocks or shares in their equity and assets on the open market.
There are 2 types of stocks that corporations commonly issue to raise funds: common and preferred stocks. Investors can make money on stocks by buying these stocks low and then selling them as soon as the price increases, or buying stocks that pay out dividends.
In terms of investments, stocks have historically outperformed all other investments in the long term – the catch is that they are among the riskiest investments.
There are many alternative investments that don’t fall under the usual categories like cash, stocks, bonds, or mutual funds. And in recent years, demand for alternative investments has grown, as we’ll see in this video:
Some alternative investments can include:
Investing in real estate can be lucrative. And, as an investment, it can be as straightforward as directly purchasing commercial and/or residential properties, then charging rent or selling them after their value increases.
Another way of investing in real estate is to buy shares in Real Estate Investment Trusts (REITs). These investments work like mutual funds, in that a group of investors pool their money to buy properties. REIT shares can be traded like stocks or give dividend payouts.
Read more: The pros and cons of REIT investing
This refers to tangible resources. Gold, silver, crude oil and even agricultural products like frozen orange juice concentrate and pork bellies are among these actively traded alternative investments. The way that these commodities are traded is via a commodity pool or managed futures fund.
This fund works as a private investment tool that combines contributions from a pool of investors who want to trade in the futures and commodities markets. The main benefit of investing in a commodity pool is that individual investors have their risk limited only to their financial contribution.
Similar to mutual funds, private equity funds are pooled investment vehicles. This is usually managed by a private equity firm, which pools money from multiple investors, then makes investments on the fund’s behalf.
In many instances, private equity funds take controlling stakes in an operating company and actively manage the company to boost its value. Private equity funds may also be invested in startups or fast-growing companies. This type of investment leans toward long-term investments that can take a decade or more.
Also called the financial lifecycle, this lists different life stages and their correlating financial goals and priorities.
It’s important for beginning investors to consider at which stages they are in. This will help them determine their financial goals and risk tolerances to better help them decide which investments suit their needs.
Here’s what the investment lifecycle looks like:
Those who just joined the workforce comprise people in stage 1. You may be making contacts in your industry as you start a career. You may own a few basic assets like a car, some furniture, and casually dabble in mutual funds. There will likely be debt in the form of a car loan and/or student loans.
Priorities: Build or improve credit, pay off high-interest debt, career advancement, put money into savings accounts regularly.
You have a nest egg consisting of a hefty savings account that provides some financial comfort. Debts are paid off or manageable. You might invest more aggressively or need to budget for expenses, as you have children and/or a mortgage. People in this stage may grow their investment portfolios or build a business.
Priorities: Build wealth and invest money into retirement plans.
This stage is for late-career professionals with relatively stable, higher incomes and a good investment portfolio. Most people are comfortable with managing their finances and have figured out how to stabilize their wealth. Although not quite retired yet, anyone in this stage would or should consult a wealth manager to ensure their investment strategy is good enough for retirement.
Priorities: Preserving and maintaining wealth for retirement.
You’re retired, or you might choose to work part-time or on a volunteer basis. These are (hopefully) your golden years when you’re able to enjoy more time with family and friends or accomplish personal goals and hobbies. Your mortgage is paid off.
While you’re enjoying the fruits of your investments and labour from the previous stages, you still need to make your income and savings last. You need to be more mindful of how you spend your money since income is less and savings won’t last forever. If you haven’t written a will, this stage of the investment life cycle demands it.
Priorities: Maintaining a budget to make smaller income last, ensuring your wealth goes to future beneficiaries according to your wishes.
Knowing at which stage you are in the investment lifecycle can help you pinpoint crucial information about yourself – your goals, time horizon, and risk appetite. These can then be the basis for your investments and investment strategies.
As you assess your financial goals, risk tolerance, and decide on which investments to put money into, it’s important to understand the importance of risk and return:
The greater the risk of an investment of losing money, the greater its potential for a substantial return. The reverse is also true: the smaller the risk, the smaller the potential return. This is sometimes called the Risk-Return Tradeoff.
This is achieved by diversifying your portfolio with investments ranging from the most to the least risky. This way, some of your investments can potentially give strong returns while others ensure that part of your principal is secure.
While it’s true that investing is a complex process, seasoned investors will tell you that it’s more of an art than a science. However, beginning investors can do these steps:
Investing can potentially be one of the best life-changing decisions you can make, but starting out is a real challenge. As you begin, it’s best to avoid complex investment strategies and opt for a popular one.
For instance, you can do buy and hold, coupled with passively managing index funds. As you slowly learn the ropes, gradually try out different investing strategies and investments.
The investment landscape can be equal parts scary, exciting, and challenging. At this stage of your life, is investing something you’d consider? What investments appeal to you now? Tell us in the comments!
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