How To Invest Your Money Wisely.
When you deposit money in an account, it doesn’t just sit there. Indeed, the bank will always use the money for its operational and investment activities.
Since the institution borrowed those funds from you, it credits you with a small interest payment less management fees.
So the question is can you have more control over those investment activities?
For example, you can decide how and when your money should be invested.
My friends and I always ask ourselves how we can invest our money. Like many people, we are always looking for simple and comprehensible ways to earn interest in relatively small amounts (less than $10,000) without taking too much risk.
Turns out if you even have as much as $500, there are several options for you to make money on that principal.
Once you have determined how much you will invest, for how long, and the level of risk you are willing to take, you can set up a portfolio with the help of a financial advisor or a broker.
Let me first explain in simple terms what kind of financial instruments may end up in your portfolio.
Understanding Asset Categories
There are different types of assets you can invest your money in. Below are 5 types of assets you can invest your money wisely into.
Equity is a portion of the ownership of a company that is sold through an instrument called a stock.
Some stocks pay dividends on a periodic basis, which represent a part of earnings that the company chooses to redistribute to the shareholders.
We distinguish public equity from private equity. The first is exchanged on a stock market whereas the latter is traded within private funds.
In addition to dividends, you can also make money on equity by reselling your stock at a higher price than the one you bought. This is called a capital gain.
Tip: Once issued by the company, a public stock has a life of its own; meaning it no longer reflects the value of the company, but instead the value other investors think the company is (or will be) worth at a particular point in time.
This may result in a higher return on your investment, or a higher loss (market risk).
You can lend money to an institution for a predetermined period of time and at a certain rate of interest by buying bonds.
Bonds pay you interest (coupons) on a periodic basis until maturity, at which point your initial principal is reimbursed. You make money through the coupons you receive.
Tip: Unlike dividends, coupon payments are mandatory for the bond issuer. This makes fixed-income investments typically safer than equity; nevertheless, bond buyers are still exposed to risk.
The bond issuer may default on payments, the coupons may not keep up with inflation and the bond may be hard to resell.
Raw materials (gold, iron, silver), agricultural products (wheat, cotton, coffee) and natural resources (oil, gas, coal) are examples of commodities you can buy.
You would not physically own these; instead, you would make money by trading futures. These are contracts that allow you to buy or sell the commodity at a predetermined price.
Tip: Commodities are a good way to diversify a portfolio because they are always in demand; however they react very quickly to global external factors, which makes them riskier for individuals.
You can buy dollars, yen, or euros in exchange for say pounds. Similar to commodities, you would not physically own the currencies; instead you trade pairs of currencies based on your expectations of their exchange rates.
Currencies are liquid but very sensitive to economic and political factors thus they require constant tracking.
5. Real Estate
You can invest in real estate without owning a property by buying REITs (Real Estate Investment Trusts).
A REIT is created when a corporation (or trust) uses investors’ money to purchase and operate income properties. REITs are bought and sold on the major exchanges, just like stocks.
REITs do not appreciate much in value (lower capital gains than the stock market) but they have historically paid high and steady dividends (better performance than the bond market). It also is an excellent way to diversify your portfolio.
Tip: The ideal time to buy REITs is during periods of low-interest rates and a down stock market. Conversely, when the stock market is booming, returns from REITs are not as attractive as average annual returns from stocks.
This summarizes the types of assets you can invest in.
Basics Steps to Set Up Your Portfolio
In this section, I will explain the basic steps to set up your portfolio with popular financial products.
Option 1: Investing with a financial advisor
If like many people you are not willing or able to manage your investments; you may require the help of an advisor from a financial services company.
It may be your local bank, an insurance group or a financial advisory firm. Those institutions offer a wide range of products depending on your objectives, your risk aversion and the initial amount invested.
Once you buy an investment product through a financial advisor, your money goes to an investment fund.
This is a collective scheme where money is pooled from many investors to purchase securities and redistribute profits and losses.
Investment funds gather investors who are willing to invest in the same kind of securities (money market, fixed income, equity or hybrid); a popular example is mutual funds.
Since your money will be mixed with other individuals’ assets, you can benefit from economies of scale and risk diversification advantages that come from investing as a group.
If investment funds seem too risky for you, you may consider guaranteed investments, which comprise all products that ensure a specific rate of return on your principal.
Examples are Certificate of Deposits and Guaranteed Investment Certificates (names may vary by country).
Typically you will have to lock in your money for a pre-determined period of time for the guarantee to apply.
In this case your funds are still invested in the financial markets, the difference here being that the bank commits itself to give you a certain amount of money after a period of time.
Tip: When crafting your investment strategy, consider using tax-friendly vehicles like tax-free savings accounts, Individual Retirement Accounts (IRA) or Registered Savings Plans (RSP) to host your portfolio of securities.
Option 2: Direct investment
You may want to make your own investment moves, tackle an industry that is not offered in packaged products or avoid management fees that are common with investment funds.
In this case, one interesting option is to open an account with a brokerage firm (or the brokerage department of your bank) to buy and sell instruments of your choice.
The broker will trade on the market on your behalf, based on the orders you placed. You may get assistance and counseling over the phone or online.
A discount broker is a company that exclusively works online, allowing you to trade at a lower commission.
You can then pick and trade-specific stocks, commodities, REITs, currencies, or derivatives, depending on the specialty of the brokerage.
Popular instruments these days are Exchange Traded Funds (ETFs), which you can also buy through a brokerage. ETFs are units of investment funds that trade on the market.
They generally track indices on stocks, bond or commodities, which limits your company-specific risk and gives you the flexibility of getting in and out of some markets by buying or selling your units.
Tip: Regardless of the option you choose, make sure you always stay aware of the global economic dynamics, geo-political events, and industry-related issues.
These may affect your portfolio directly or indirectly through the resulting changes in inflation, interest rates and growth rates.
That’s all on how to invest your money wisely.
I hope this article was helpful?
This article was written by Meinna Gwet.