Read the Tagalog Version of this article: Investment 101
Alas! You have known the value of budgeting (if this is your first time here, I suggest you to read my previous article on How To Make A Budget Plan). And we have learned that a budget plan should not only include your income and expenses but as well as your savings. And this savings should also cover your emergency funds (I have discussed this on my article Building Your Emergency Fund) and your long term and short term goals (I have discussed this in my article Planning Your Financial Life Goals ). This time, we will talk about where you can put and keep these funds. Of course, it must not be inside a piggy bank. How about in bank? Well, it will be good to keep your funds in a bank thru a saving account. However, the interest rate of a saving account is very minimal. In the Philippines, some banks only offer an interest rate of about 0.25% in a year. So, if you do so, the rate of interest of your money will never beat or win over the rate of inflation.
What is Inflation?
Wait a minute, before anything else let us first define the word inflation. Inflation is the continuing rise in the general price level usually attributed to an increase in the volume of money and credit relative to available goods and services. To better understand it, inflation is the reason why a monetary unit decreases its value and purchasing power. Here in Philippines, there is a continuous depreciation of peso every year.
According to the study, the inflation rate of a developed country is about 2% to 3%. So if you just put the money in a savings bank account with interest at 0.25% per year you are still losing 1.75% to 2.75% due to inflation.
What is the effect of inflation on us? If you are here in the Philppines for example and you have Php.100,000 in a bank savings account this year, by next year your money is no longer of the same value. Yes, it may appear to have acquire a little interest, but actually, decreases its value as well of its purchasing power. The things your money can buy this year is not the same by next year. You may manage the day with just Php 300.00, but maybe you will need Php 500.00 to manage a day by next year. The effects of inflaton are very visible even as you wake up in the morning and you buy “pandesal” (famous salted bread in yhe Philippines) to your favorite bakery. Few years ago you can buy this bread for 1 peso each, but now buying the same size of bread costs 2 Pesos each. Or maybe in most bakeries, the worth is the same but the size is a lot smaller than before as if it is only about a bite size like siomai (dumpling). Get my point? So even if you keep the money in a savings accounts or even in time deposits, inflation is like termites in the house eating your money. Inflation lowers the value of your money even we put it in the bank.
Now, the bigger problem is this, you are in the Philippines my friend. And because we are not a developed country, the rate of inflation here is not only 2 -3%. Do you know that from 1973 to 2008, the average inflation rate in the Philippines is about 11.1%? The largest was in 1984 before the EDSA Revolution, the inflation rate rise up to 50%. With this report, if you have saved Php 24.00 in 1972, its value on year 2008 or 2009 will be…. (DRUM ROLLS please … jan-ja-ra-ran!.) ….. 0.65 pesos or 65 centavos! It means, at this rate, your portfolio may be down by almost half or more every ten years.
That is why we need to do something to beat the inflation. How? We have to think of some ways to increase our income. You can double your effort and have additional sidelines or source of income. Another thing is to have an investment.
What is an investment?
Are you now getting an idea of what an investment is? I mentioned earlier that we need to find another source of income right? To easily understand, the investment is a way of placing or committing money (as capital) which we expect “something in return”. Of course we only issue money if we do expect a return or if it will profit us. It’ natural. In the world of Finance, you’ve probably heard the word ROI or Return on Investment. In other words, this is what you’ve earn through your drawn money or capital.
As I have mentioned earlier, we need to invest to beat the inflation rate. Do not forget that this is our main “purpose”. But before you invest you need to complete your “financial life goals”. If you have no idea about it, read my article “Planning Your Financial Life Goals” before you continue reading this article.
If you already read the article I referred to, I hope you now have the list of your goals.
Before you invest make sure you also have completed your “emergency fund ” (To know more about emergency fund, read my article: “Building Your Emerency Fund“). Why? It is inappropriate to invest your emergency fund because you will be placing your money to something that you can not easily withdraw. Thus, we can only invest are those short-term goals and long-term goals. Make sure that the money for investment is just an EXTRA CASH of yours.
Now, if your Financial Life Goals are clear, the next step is for us to know your “risk profile”.
What is “risk profile”?
Risk profile is generated by answering these 3 questions:
- What is your investment objective?
- What is your investment horizon?
- What is your investment personality?
Why we have to invest? The answer? Because in addition to our need to beat inflation, you must also satisfy your written plan or your Financial Life Goals.
Depending on a person what he wants on his investment. The objective can be:
- Preservation of capital - in other words, making the amount of money you have to remain the same. For example you received a “retirement benefit”, of course you do not want to reduce or decrease your retirement benefit that can be use as your capital.
- Regular income - you can rely that from the capital you will have a regular income from investment profits or interest. As from previous example, if someone used his “retirement benefit” as capital, of course he would like his money to earn additional that will serve as his regular source of income even though he no longer work.
- Growth in capital - This is what we mostly like to happen to our money. To make our investment grow and expand. Making our capital to grew and grew and let the money work for you and become a stable passive income.
How long do you want to investment your money? If you want to have an out of the country vacation next year, the investment horizon you selected is too short. Usually it is related to the deadline you have set in your Financial Life Goals. It also related to the age of an investor. How long before you retire from work? The investment horizon is also composed of 3:
If you belong to age group of 30 to 40 years old, you can invest in the long-term investment horizon. You can invest in investment with high “risk” of losses. Yes, you can loose into an investment. But that’s fine, you’re still young and able to recover in case. Those people who stumble have a more durable knee. LoL … are you frighten when I said high risk of loss? Do not be afraid because they also meant bigger earning. The higher the risk of an investment, the bigger its ROI. This principle is true and applicable even to any business. And while you release bigger amount of money, the bigger income you can expect from it as well. So the longer time you have to invest, the more you will understand the market “cycle”, its ups and downs. This will work for your advantage. Therefore, a long term investments are highly recommended for this age group.
If you belong on the age group of 40-50 years old, we can conclude that a mid-term investment horizon will be fine. Here, we need to be somewhat careful in investing. But you can if you still want to invest with a high risk. This may depends on what have you set out to your financial life goals.
Lastly, if you belong to age group of 50-60 years old who intend to retire at work. Typical category for this is a short-term investment horizon. Often, the objective is more on “preservation of capital” with a regular income. But if you the person is thinking of his children’s and grand children’s inheritance, he can still fight with the high risk investment built for a short time period.
It is the personality of an investor which tell you how much risk you can take and how strong your will is. Here, you’ll hear words like “conservative” and “aggressive” risk profiles.
Usually if you go to a bank and have decide to invest, you will be ask to answer a written questionnaires. Do not be afraid, no one passed or failed with it like in school examination. The purpose of the questionnaires is to assess and guide you where you should put your money. They can tell your risk profile, weather your a “conservative”, “moderate”, or “aggressive” type of investor. What is a conservative risk profile? They’re those who are afraid to failed and lose money. Well we all do fear to fail of course but this type of people will be thinking restlessly once he invest his money in high risk of losses. If you are one of them, they will advice you not to invest in the investment instrument like stocks and equity because maybe you will have a heart attack if you suddenly see the ups and downs of the stocks market.
While if you have a high risk profile, they would allow you to put money in any investment instruments with a high risk. So if you are targeting such investments, answer the questionnaires with courage even if it means that you might loose your money. Remember, the higher the risk, the higher ROI. But of course we must be wise to investing in this type of investment.
If you are not too aggressive yet not too conservative, lets just say is in the middle, you can do with a medium risk investments like Balanced Equity. This is for investors with “moderate” risk profile.
What are different investment instruments to keep our money?
Now that you know your “risk profile”, you can decide what investment instruments you like to place your money. What are investment instruments or investment vehicles you can use? This is where you can hear bank products like Trust funds or UITF, Mutual Funds, Stocks Investing, Stocks Trading, and more. I mentioned earlier about Balanced Equity, it is an example of bank product under to one of the investment instrument.
Investment instruments are divided into 3:
- Cash and Money Market Instruments
- Stocks and Equities
Cash and Money Market Instruments
To easily understand, our savings account belong here. Under this investment instrument are those with has fixed income and a maturity date that usually 1 year or less. Fixed because as saving account, it guarantees your money by just 0.25% interest in one year. Others are Time Deposit Account and those called Treasury Bills (T-Bills).
Bonds are a kind of “debt instrument”. It means, your money is being loaned(lent) to a corporation or to the government itself. It almost a risk FREE to invest in the bonds being a government-issued if the government is a “stable government”.
This probably the type of investment instruments that you want to hear and learn more. In all of the investment instument, it has the largest possible profits, but it also has the biggest chance that you will loose if not provided an enough time to study and understand.
This investment instrument has the same principle to a Buy and Sell. Same as the typical market, the stock market has buyers and sellers. The only difference are the types of goods or commodities. This sells the stocks of different companies. As an investor, you can be at the same time become a buyer and a seller. As a “buyer”, you’re looking for opportunities to buy stocks at low cost. And as a “seller”, of course you want to sell anything you bought at a larger amounts. The applicable principle here is “BUY LOW, then SELL HIGH”.
Under stocks and equity, other bank products included here are those you often hear like Mutual Fund (MF) and UITF (Unit Investment Trust Fund). But they have different processes and more diminish or narrower scope since only “SHARES” and “UNITS” of funds are being discussed in here.
Until here for now. In the next article I will discuss thoroughly our investment instruments where we can place our money. Wait for my article about investing in Mutual Funds, UITF and Stocks.
Investing is not just for rich people. Many banks and financial institutions offer different investment instruments at low cost. If you have an extra Php 5,000.00 in your pocket and your emergency fund is already intact, you need to start investing. Just like the favorite expression of Ms. Kris Aquino (an actress here in the Philippines): “Now na!” (“It is now!”). The best time to invest is NOW.
And always remember, the harder you work to earn a certain amount, the hardest for it to save, invest and multiply.
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