Follow by Email

Investment 101 - Basic Concepts

Sunday, December 2, 2012

I know a lot of people who want to invest but have none to little knowledge about it. Having graduated from business school with enough knowledge on investment concepts and actually investing already, they ask me to talk them through it and give some tips, which I was very willing to do so. And that's when I realized this as a calling of mine - to educated people on investments and financial planning. And in order to reach more people, I created this blog. :)

So to you reader who I assume is very interested in investing thus landing on this blog, below is my first lesson to you. To kickoff your investment plans, you need to first understand 2 very basic concepts in order to manage your expectations regarding investments.

1. TIME VALUE OF MONEY

The value of money does not stay constant, it changes throughout time. It can work against you because of inflation, or it can work to your advantage through investments.

Inflation is the yearly increase in the cost of basic goods. Let's say you put $100 in a bank deposit where it stays there for 5 years. At 5 years, the nominal value of you money did not change, it's still $100. BUT, what did change is the value of the items you can buy with 100$. Before, you could probably buy a full cart of groceries. Now, you can only buy a basket full of groceries.

So if you're someone whose saving money consistently  for retirement and putting it all in a bank, you might not actually be doing yourself a favor since whatever you are saving, it's value would have been brought down significantly by inflation when you retire.

This is why it's very important to invest. By definition, an investment is an instrument where there is an expected amount of return to be gained. There are a myriad samples of investments but there are 3 which are very popular and widely discussed - stocks, bonds and mutual funds.

To know more about stocks bonds and mutual funds, CLICK HERE.

By putting your money in investment instruments, you can beat inflation AND earn additional revenue. If you put $100 in an investment and let it stay there for 5 years, if it's an agressive investment, then it might have already become $150-$250 already.

2. RISK AND PROFITABILITY TRADEOFF

All investments have a tradeoff between profitability and risk. If an investment promises higher returns, the tradeoff is that there is more risk. If it promises, less risk, then the tradeoff is that there is lower returns.

We define risk as the variability of returns. This means that if an investment promises higher returns, there is NO guarantee. The performance of the investment will depend on the market. If the market is bullish (upward trend), then it can earn very high. If the market is bearish (downward trend), then it can earn equally big losses. An example of a high return, high risk investment is stocks.

If the investment promises guaranteed constant return, whether the market is up or down, the tradeoff is that it won't be a high return rate. An example of this is bonds. Bonds offer a fixed rate of return and thus can guarantee you that return even if the market is bearish. But if the market is bullish, you miss out on the potential to earn more. Also, bond rates are generally way lower than what you can potentially earn in stocks.

There is no perfect instrument that can promise high returns with low risk. If someone promises such to you, be wary! It's either that someone doesn't really understand what he is talking about or it's a scam. If there is such a perfect instrument then we'd all be rich, but were not. A good question to throw at anybody selling you an investment is to ask them how it works; how does it earns money; and how much involvement is required from you?

To know more about how stocks bonds and mutual funds work, CLICK HERE.

Keep these two concepts in mind always as you will encounter them a lot especially when you start investing already. More articles to come so subscribe to this blog now! :)



blog comments powered by Disqus

Search This Blog

Blog Archive

Popular Posts

CAREER ADVICE

EXTRA REVENUE

INVESTMENTS

PEOPLE

FINANCE

INSURANCE

OTHERS