Investing 101: What You Should Know Before Investing

You might be reading this because you finally want to invest but you don’t really know where to start. I created this Investing 101 to explain to you the basics.

I remember how I opened my first BPI Trade account (an online trading platform in the Philippines) and closing it just after 3 months because I just did not know back then what to buy and how to trade and I had no purpose.

But I am not here to talk about techniques regarding trade. I am here to explain to educate you about the things you need to understand first before investing.

 

1. Saving and Investing

When you save money, we don’t usually expect that money to really earn something. When we save we usually use that money for emergency funds or something that we could easily “liquidate” or something that would be easily accessible if the need arises.

The most common example of this is saving your money in a piggy bank or in a transactional savings account. Although transactional savings account offers interest rates. The real rate of return which is the inflation rate subtracted from the interest rate is not really great.

Most banks offer interest rates at around .80% or below per annum. The inflation rate would always be higher than this at around 2-4%. So looking at the real rate of return, your money in real life is losing its value.

When we speak about investing, on the other hand, it involves purchasing a financial asset that would give us a return or an income. We are buying an investment that we expect to have a return greater than the current inflation rate in the country we are in.

The other difference is returns from an investment is not guaranteed. An individual investor is faced with the risk of losing money since most of the value of investments are determined by fluctuations in the market (demand and supply).

 

2. When is the Best Time to Invest?

People would always ask, when should I start investing? Am eligible to invest now? Investing nowadays is easier than investing before with the introduction of free seminars given by banks as well as other brokerage company to get us started.

But here’s my take.

Before you invest make sure you’ve covered these first:

a. You don’t have any debts. – It would be hard to invest your money if you have an existing obligation to pay something. Start investing when you don’t have any liabilities especially if its credit card bills where the interest or finance charge you might be paying is even greater than what you are earning from your investment. Unless your return would really cover the interest charges of your debts (but as a beginner, I wouldn’t really risk that because higher investment returns involve higher risk investment assets too).

b. You have an emergency fund – Tally and compute for your monthly household and personal expenses and multiply it by 6-7 months. That should be your emergency funds.

Emergency funds should be your first line of defence if something happened to you-  if you resigned; if you were laid off; if you were injured and was hospitalised or not able to work. Because if you will get your emergency cash from your investment since investment is not guaranteed, either two things will happen: 1. You lose your investment especially if the value of it has not appreciated 2. You will short live your wins just in case your investment’s value is already appreciating.

If you think that you have covered both, then I think the best time to start investing is NOW.

 

3. Investment Asset Classes

There are different asset classes. Each investment asset class involves a different risk, different return, different volatility, cost, liquidity. You have to know these first to give you options and to help you in your decision making.

Each investment asset class has a different risk-return. It is said that the lower the risk is the lower the return, while the higher the risk is, the higher the return.

The major asset classes include the following:

a. Cash

b. Fixed Interest

c. Property

d. Equity (shares)

The difference between the four asset classes are the following:

	Cash	Fixed Interest	Property	Shares
Examples	bank accounts, short-term deposits, treasury bills	bonds (corporate and government), term deposits greater than 1 year	residential, commercial, industrial direct property, real estate investment trusts (REIT)	shares in a listed company (stock market)
Return	interest	interest	rent or distribution (REIT)	dividends or capital appreciation
Risk	low	medium to low	medium to high	medium to high
Volatility	low	low	low except for rent (where there would be a hard time to find tenants )	high (share values are subjected to daily market valuations)
Liquidity	high	high	low (properties are hard to disposed right away)	high (as long as there’s a buyer that will match the seller’s price)
Cost	low	low	high	low (only brokerage fee or other small fees)

*this is just a simple representation, there are other products that could still be included to each asset

 

4. Investment Time Horizon

As a future investor, you have to know as to which asset would you like to focused with.

For example, for cash asset classes, it would be better to put your emergency funds here because the liquidity is high which means it is easily accessible and the risk is very low too.

For your two to three years investing need like education, travel or home improvements, you might want to choose fixed interest asset that is usually in a form of bonds which would also give you a return that could be higher than just putting it in a cash

For shares on the other hand, since it has a high volatility, it’s better to put your money here for a longer term horizon around 5 years and above to manage the risk of volatility.

 

5.  Diversification

You don’t have to put all your eggs or money in one basket. This is the very essence of diversifying your investment.

Here are the two most common ways to diversify an investment to reduce risks:

a. Across asset classes – you can have cash, fixed interest products, shares and properties with you. One way or the other, the performances of these products would differ from one another and you could greatly benefit from the differences if you have all of it.

b. Within an asset class – this is very common when you invest in shares. Shares that are listed in the stock market are from different sectors. One could be a bank, a consumer good, a construction, a property, a holding company etcetera.

Diversification is great so that the return of a single investment from one asset class would not greatly affect the overall return of your total portfolio. If you are able to diversify well, a negative return from your shares could be compensated by a positive return from your fixed interest rate.

The benefit of diversification is that it reduces the impact of a loss of one particular asset.

Now that you know these, the best way to start is to ask yourself:

 

What type of risk are you willing to accept and what are your financial goals?

 

Once you answer those questions, you’ll know what type of asset class or investment diversification you would choose for yourself.

Remember that investing should be done wisely. You have to conduct your OWN research or perhaps join free basic seminars, especially for stocks/equities before you invest your hard-earned money. Like what they always say, investing is not a magic or an instant win. It takes time. So start slowly, enjoy the experience and start making your money work for you!

 

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