The #1 rule of investing is to start as soon as possible. But, where do you begin? And how much to invest?
It all begins with working out your monthly spending expenses such as rent, utility, groceries, debt and internet (a modern-day essential). Once you have sorted these areas, keep aside a little cash (savings). It is this amount that you shall invest. Also, start reading up about investment analysis. But, before delving into the investment avenues, you must understand the principles of investing. These are next.
The Principle of Risk and Opportunity
The world of investments rests on risk versus reward. Although adversaries, risk and reward go hand-in-hand. The investment avenues that provide higher potential growth or profit also carry higher risks and vice versa.
The Principle of Fundamental Research
The principle of fundamental research is based on insights based on economic data and reports.
In the United States, for instance, investors can refer to reports such as the monthly Non-Farm Payroll (NFP), the Producer Price Index (PPI) and Gross Domestic Product (GDP). Apart from these, annual reports of companies offer considerable insights into the fundamentals. They contain the financial statements, earnings reports and ratios such as debt/equity ratio, earnings per share and price/earnings.
The Principle of Technical Analysis
The technical analysis rests on price and trading activity. There are no fundamentals such as economic reports and company information. Many investors today prefer to make investment decisions based on market factors. Technical analysis entails price charts and patterns, technical indicators, and market information (trading volume). These aspects then help predict the probable future price of a security.
Now, the peculiarity of technical analysis is it is favoured for short-term and day traders. The long-term investors, on the other hand, provide higher weightage to fundamentals. The reason is that when contemplating trading within a single trading, economic indicators do not have much impact. It is the technical factors and price movements that have greater precedence.
Now that the basic principles and analyses are known, next up is evaluating the asset classes. There are several out there. Let us first look at the ones people are most familiar with – equity and fixed-income investments.
Equities or stocks are the most common asset class. It involves buying and selling stocks in publicly traded companies. It is the first asset class that most people think of when they come across the word ‘investing’. So, what do publicly-traded company stocks do and offer? First, they offer investors an equity interest in the company. Let us say that the shares of Vanguard are trading at $1.5 per share; you can then buy a hundred shares for $150. What selling the shares does is that it allows companies to raise capital for growth and expansion. What stock investors get from transactions in shares is a benefit from price appreciation and even dividends. Dividends are akin to an earning interest or bonus on shares owned. These stocks then get traded on exchanges such as the New York Stock Exchange (NYSE) or London Stock Exchange (LSE). These exchanges, in turn, help regulate and facilitate equities trading.
Fixed Income Securities
Investments in debt securities and are known as ‘bonds’. Investors stand to gain fixed-rate interest payments over the timeframe, making it a fluctuation free return. You see, the bond market is among the largest today the world over, thanks to the massive debts carried by governments. So, what purchasing a bond does is that it helps provide financing to the company. In turn, investors get remuneration through a specified interest rate, which is known as the coupon rate. This interest payment can be semi-annual or annual. Note that the interest is only paid until you receive the principal amount at maturity.
So, what is this coupon rate?
It is the yield offered at the time of issue. Now, the coupon rates do not change over the bond’s life. But, when the interest rates fluctuate (up or down), the value of the bond (or yield to maturity) changes. These changes affect the value and yield of the bond. The correlation is that when interest rates increase, bond prices reduce, and vice versa.
Who can issue bonds?
Bonds are issued by corporations and governments – national, state, and municipal governments. What makes government bonds a go-to choice is a tax-free interest.
So, what’s the difference between government bonds and corporate bonds?
The latter offer higher interest rates but also carry higher risks. So, revisiting the risk versus reward equation, government-issued bonds are safer than those issued by corporations.
Other Asset Classes
These are the lesser-known ones and hence, are alternative investments. It includes asset classes such as commodity futures and forex trading. The point of attraction and benefit of these asset classes is leverage. What leverage does is that it allows investors to use relatively small amounts of capital to control a large investment. For example, commodity futures typically provide leverage of 10:1. So, if you want to invest in a 100 gold futures contract, you have to put up (or deposit) only 5 to 10 per cent of the contract value.
So, what then is the benefit of leverage?
In simple words, it allows investors to make a lot of money using small upfront capital. It applies to both positive and negative investment outcomes. They amplify not only profits but also losses.
Point to Remember: These alternative investments are generally less liquid than the traditional classes.
Where do you go from here?
The questions raised initially, ‘where to begin?’ and ‘how much to invest?’ rest a lot on your risk tolerance and investment objectives. If your plan is, say, to stay invested for the next twenty years, going equity is an ideal strategy. Alternatively, if you are investing for a shorter-term goal, say marriage after five years, you are better off opting for safety. In this case, debt is ideal. There are other avenues such as Mutual Funds. These have grown in popularity in the last few years too. In line with this, one investment strategy that you should definitely look into is SIP (Systematic Investment Plan). The best part? You can start with whatsoever amount you like.