by Moses Ayiku, Jr. MBA OP/ED
Last week, we discussed banking and bank accounts. Too many people do not have bank accounts, and this brings many challenges. Please visit a bank and find out the requirements for opening an account if you do not have one. Then develop a plan for obtaining all the documents necessary to open an account. An account will provide easier access to your earnings and assist you to develop an effective saving and budgeting plan.
This week we will begin to look at investments. We will start by discussing why we should invest, the different types of investment and how to invest in the stock market.
Why should be invest our money? Many of us have heard of the phrase, “making your money work for you.” What this simply means is that one places excess funds (or savings) into investments that provide a return. While there are a variety of investment instruments out there, most people refer to stocks when they are speaking about investments.
Making your money work for you means you focus on your main income source if it is a full-time job for example. Then you put aside funds every pay period which you invest into financial instruments that provide a positive return. One key to guide you when you are looking at investment options is to compare the different rates of return. One investment may have a guaranteed rate of return of 5%. Another may have a fixed return of 10%.
Naturally, we are more inclined to invest in financial instruments that provide higher rates of return. Rate of return means the amount that one gains per period over and above the initial investment. For example, if I investment $100 in a financial instrument and I get $110 by the end of the year, then that investment has given me a 10% return on my money.
The formulae for calculating the rate of return is: Return = (End/Beginning) – 1
In our earlier example, we initially invested $100. That would be our beginning investment. We ended the period with $110. That would be our ending balance. The investment thus gave us $10 in one year.
Our return would then be calculated as: (110/100) – 1 = .01 or a 10% cumulative return on investment
Understanding the rate of return and how it is calculated is very important because it assists us in comparing different investments. If one investment would give you a 10% rate of return while another would give a 20% return, then the 20% return would seem much more attractive. Please note that it is important to consider other factors apart from the rate of return, such as the risk level. Normally in investments, financial instruments with higher rates of return may carry higher levels of risk. Also, not all rates of return are guaranteed.
We invest our excess funds or savings because we want the money to grow. If you were to put money under your bed for 10 years that would be a bad idea. Why? Because the money would not grow in value! Rather, that money would lose value over time. Due to the impact of inflation, money that is not invested, tends to lose value. In other words, money today can be worth more than money tomorrow. Inflation refers to the general increase in price levels over a period. In 2020 the US inflation rate was about 0.62%. In 2019 this rate was about 1.81%. Inflation is referred to at times as a thief! Because it reduces the value of money and in effect how much one can buy with one’s money. The key is to invest excess funds and obtain a rate of return that is at least higher than the rate of inflation. If for example, you invest in a financial instrument and get a rate of return of 5% then you would have beaten the rate of inflation. That is a step in the right direction.
There is an array of investment options out there. Each investment type comes with different risk levels as well as investment amounts required. Investments also differ in terms of the type of return, the rate of return and the duration of the investment.
The following is a list of some investment options:
1. High-yield savings accounts
2. Certificates of deposit (CDs)
3. Money market funds
4. Government bonds
5. Corporate bonds
6. Mutual funds
7. Index funds
8. Exchange-traded funds (ETFs)
9. Dividend stocks
10. Individual stocks
11. Alternative investments
12. Real estate
We will discuss each of these over the coming weeks. The term investment can also be used to describe the process of using one’s funds to start a new business. This is often described as a direct form of investment. Most investors try to avoid direct investments because they may require much more time to manage, carry higher risks and also may require larger amounts of money. We will look at direct investments in the coming weeks as well.
This week our focus is on investing in stocks. The stock market is a major avenue for investing funds. Insurance companies, corporate entities, pension funds, hedge funds and individuals all invest in the stock market. The stock market has the potential to allow one’s funds to grow over time. For the average investor, it is recommended that one invests with a focus on the long term. In other words, it usually pays off well to buy and hold onto stocks for years to gain from your investment.
There are several stock market gurus who have gained tremendously from investing on the stock market. One of such investors is Warren Buffett. Mr. Buffet is currently worth about $100.6 billion. It should be mentioned that Mr. Buffett has been an investor for decades. In addition, he takes major stakes in companies and obtains board membership/management roles which allow him to positively influence the direction of some of his investments. Through his firm Berkshire Hathaway, individuals can invest in his fund and enjoy the benefits of his expertise.
Investing in stocks is a risky proposition. However, it pays to first understand the market and how it operates. There are varied types of research and analysis that one can undertake to minimize the level of risk associated with investing in the stock market. There are also different stock markets and it is important to know more about each market and how it operates.
The stock market has created a great amount of wealth over time. The S&P 500 (Standard and Poor’s) consists of 500 of the largest U.S. publicly traded companies. It is used to provide us with a glimpse of how companies’ shares on the market are performing on a regular basis. Rates of return have averaged about 8% to 12% per year. If one had invested $10,000 in the stock market 50 years ago, it would have increased or grown into more than $380,000 today.
A big caution though; stocks do not rise every year! Typically, the S&P 500 falls three out of every 10 years. At times the market can be quite volatile. A key step is to make sure that you understand the stock market quite well before beginning to invest. There are some pillars of knowledge that one should learn before taking the plunge to invest in stocks. Next week we shall discuss more about the stock market and the pillars of knowledge required to invest effectively.
Please feel free to share with me your questions and experiences on stocks and investments. I will do my best to respond, and in some cases, I will write on some of these questions.
Your questions and comments can be sent to localtalknews@gmail.com.
