Anybody can earn money, it’s the savings and investments that count, an adage that rings true in these times of economic unrest and uncertainty. Careful investments can go a long way in securing ones future, after all, whether we call them stocks, bonds, term deposits or even simple savings accounts, a comfortable retirement is the ultimate goal of all personal finance. For the employed, investment often means putting away money for a rainy day, in stocks or funds which can be counted on, during times of economic downturn or personal requirements. Yet, for an amateur investor, just beginning his journey into the realms of finance, it may be a challenge to manage his resources according to his investment goals. Before we start discussing some investment channels, it would be prudent to glance at some tips for sensible investing.
Tips for Intelligent Investing
Goal – Setting
Goals can be short or long term, your eye may be on a beautiful Porsche in a dealership downtown, or maybe, your aspirations are more familial and it’s a home that’s on your mind. A college loan, a formidable-looking mortgage, or even a trip to one of those picture postcard tropical paradises you see so often, plastered across the centerfold of some coffee table travelogue, without a planned investment strategy spread over a number of years, one cannot hope to ever generate the amount of money required to bring any of these dreams to fruition.
All investment goals are invariably influenced by factors such as age, income, marital status and work opportunities. Setting yourself goals for investment can be a very personal, introspective look at ones stage in life, and is different for every individual. A middle-level manager in an accounting firm in his early forties, may decide to take lesser risks and not invest in funds that have a greater composition of volatile stocks, on the other hand this may be the exact opposite of what a young executive in his first or second job would do – go where the returns are the best. A more senior investor, retired or on the verge of it, would probably hold more government bonds than mutual funds or pure stocks, as he needs the assurance that a federally backed financial instrument can give him.
The Risk Quotient
There is no gain without some measure of pain, so the saying goes, and the element of risk is omnipresent once your hard-earned money is on the line, fluctuating with the market and the prevailing economic conditions. It is best to have a margin of safety while investing, so as to keep a buffer between you and these fluctuations, thereby keeping your money safe. The other side of this argument, is that it’s often the risk-takers who stand to gain the most from these corrections in the market, if they have sound reasoning to back their investment decisions. The stock market has made and unmade many good people, it doesn’t mean you have a defeatist attitude and no risk appetite, however, for those who don’t have a taste for the mood swings of the market, there are several investment options in the form of bonds and certificate deposits which will do the job, albeit at a lower rate of return.
It is advisable not to keep more than 75% of your investment confined to a particular asset class. By asset class we mean the investment vehicles like stocks and bonds. Diversification is a way to tone down the risk of losing money when the market is overcome by the forces of demand and supply, or at times, speculation and rumors, resulting in a drop in prices of stocks and the devaluation of personal holdings. One can invest in different types of securities and in funds which spread their portfolio over a range of companies, operating in different sectors of the economy.
Investing is also tying up your money in the form of a financial instrument, and liquidity is important when you want to make changes to your investment portfolio. Investing in stocks, bonds and other types of security comes in handy here, as these can be readily sold or redeemed in case of such requirements. Investing money in real estate, or in a business having a limited liability clause, may tie it up for a considerable amount of time, as there are certain legal formalities involved in the sale and purchase of such assets.
Checking for Tax Advantages
Investing can offer tax advantages too. Bonds carry certain tax benefits, an example is the US Savings Bonds which offers tax exemption at the State and local levels. Municipal bonds also offer certain tax reliefs, however, investing in stocks may incur you a tax liability as the gains from them are taxable.
Return on Investment
What are we investing for but profits, an amount gained that is in excess of the one we parted with, reducing or eliminating the opportunity costs involved in investment plans. Once again you must assess your requirements, what portion of savings are you willing, and able to invest? Which investment route should you choose? If you are a student paying off an education loan, high-stakes stock trading will not be your cup of tea, it may even lose you the few thousands leftover from the loan. It is a good idea to go for a short term Treasury Bill (6 months) or deposit your money into a savings account that has an attractive rate of interest. If you decide to indulge in some stock trading, it is best to stay with money market funds which invest in government securities and not on the open market. This investment plan will undergo changes according to the requirement of the investor, a successful software engineer may want to go for more aggressive trading, investing in a mix of blue-chip and mid-size companies that show promise. However, in all cases, the ultimate result is the generation of profit which makes all the trouble worthwhile.
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Ways to Invest Your Money
Investment methods can be classified in two ways – according to the degree of risk or the time period over which the yield may be derived from them. So you have to choose between high, medium and low-risk investments, keeping in mind the time frame too. Imagine a pyramid of your hard-earned money; ideally, the base of the pyramid should be invested in low risk, long-term investments (after accounting for your day-to-day expenses), the middle pile in short-term investments, with moderate risk and the smallest portion of the pyramid peak, into high-risk, high-return investments. Here are some of the best ways to invest in the long and short term, to ensure financial freedom in the years to come.
Open a Savings Bank Account
A safe method of investing is the savings bank account. Banks offer you a set interest for the amount of money you deposit with them. The current market, however, is still recovering from the disasters of 2008 and the Federal Reserve has decided to keep the target rate near zero until 2015, in an attempt to keep mortgage interest rates under control. So, although homeowners have something to cheer about, interest rates on savings accounts will not be very high, as banks use the Federal Reserve target rates to decide their own rates if interest. This does not mean that there are no banks out there with attractive interest rates and a little analysis can help you decide where to open an account and invest your cash. Bank accounts are known to be the safest and most flexible, if not the best way to invest money. Though the yield is low, the advantage of investing in savings accounts is the freedom to withdraw money anytime, as long as a minimum amount is maintained.
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Investing in Bonds
Another great investment option is that of a bond. Bonds are issued by private companies and governments. When you buy a bond, you essentially provide a loan to the private enterprise or the government issuing it. In return, you earn a fixed monetary interest, according to the coupon (interest rate of the bond), after a fixed maturity period. Treasury bonds or notes issued by the government are the safest investment options, with low but guaranteed yields in the long term. Bonds come in various types. A riskier, but high yield option is buying bonds offered by private companies, which are traded on the bond market. The returns on these bond instruments are subject to the performance of the issuing company. Carefully research the bond market and study the risks involved before investing. A treasury bond is always a good investment, but it has a long maturity period.
Such bonds are issued by private and public companies as a quick method of raising capital.
- Higher yield than government bonds.
- There can be a risk of default if the company suffers losses or the prevailing market conditions force it to defer payment.
- Liquidity can sometimes be an issue as secondary markets may not always accept sale of corporate bonds.
- Inflation, that many-headed monster, is always a threat as it tends to reduce the value of the bonds in the long term.
Local governments and their affiliated institutions also issue bonds, known as Municipal Bonds or Munis, these bonds are often released by cities, redevelopment agencies, school districts or any other governmental agency beneath the central government.
- Municipal bonds are tax-free, this is by and large their greatest advantage. Even though the interest rates on municipal bonds are low, they offset this by giving you a tax-advantage which closes the gap between them and other taxable bonds.
- Municipal bonds have negligible default risk as they are backed by government agencies which promise return of principal and interest.
- The biggest drawback of bond investing is the low interest rates, however, if you are looking a risk-free and long-term investment solution, municipal bonds are the way to go.
The US Treasury Department issues various debt instruments which can be a good way to invest and earn interest income. These instruments are backed by the federal government and are therefore a safe and reliable mode of investing money. There are several types of such debt instruments namely:
- Treasury Bills: A popular short-term security, also called a T-Bill, which matures within a few days to about 52 weeks.
- Treasury Notes: Known as T-Notes, they mature within two to ten years and pay interest (coupon payments) every six months. They are available in denominations of $1000.
- Treasury Bonds: T-Bonds are true long-term investment vehicles, they have the longest maturity period, extending from twenty to thirty years and similar to T-Notes they offer coupon payments at six-month intervals. However, the T-Bonds are losing popularity, having been taken over by the 10-year T-Note which also works well as a long-term investment option.
- Treasury Inflation-Protected Securities (TIPS): The TIPS securities offer inflation protection by virtue of being tied to the movement of the Consumer Price Index (CPI). The simple act of increase or decrease in the index prices causes an appropriate adjustment in the principal amount invested in TIPS, to tackle the loss caused by inflation. TIPS come in 5, 10 and 30-year maturity classes.Investing through the 401(k)
You can also opt for salary contribution plans like the 401(k), a subsection of the Internal Revenue Code. This is a type of retirement contribution plan, where certain amounts are offered as contribution towards the 401(k) fund, the annual limit being $17,500. These contributions are deducted from the employees paycheck, before any tax-deductions are made, however, the 401(k) is taxable if the money is withdrawn before 59½ years of age, the age of retirement. Many employers also undertake to contribute toward 401(k), which adds to the fund over the years.
- Tax-free deductions added to a fund you can claim after retirement, a handy sum which will go a long way in contributing to your financial security in your twilight years.
- Employers that match the contribution often ensure a profit-sharing option, enabling better returns in the long run.
- Liquidity takes a hit as most employers enforce severe restrictions on withdrawals from 401(k) accounts.
- There is an excise tax of up to 10% levied on withdrawals, not to mention the tax deductions which would invariably apply.
Certificate of Deposit
Apart from savings accounts to put money in, banks in the US also offer a financial product called a Certificate of Deposit. A Certificate of Deposit or CD as they are commonly called, is a time deposit much like a savings bank account in that it is guaranteed to be risk-free. CDs are also offered by Credit Unions, insured by the National Credit Union Administration (NCUA), the ones offered by banks are guaranteed by the Federal Deposit Insurance Corporation (FDIC). CDs offer a fixed interest rate for the amount of money you deposit with them for a particular period of time. The time-span varies from case to case, but the general span is six months to two years. The banks offer decent compounded interest on your deposits. A Certificate of Deposit is a time-honored and time-tested way of investing money.
- Interest rates offered are higher than average savings banks account rates.
- Risk-free investment as it is basically depositing money in the bank, albeit for a shorter duration of time.
- Larger deposits are often offered higher interest rates too.
- CD interest rates are closely linked to the inflation rate of the economy. This is turn causes a problem when the real rate of return is calculated. If the inflation in the economy is tagging at 7%, the CD rates will be very similar to this, as the inflation cancels out the interest income.
- Taxes are liable to decrease the real return of a CD even further.Individual Retirement Accounts (IRAs)
A form of a retirement plan, IRAs are a popular form of investment, which give you a healthy sum to bank on after retirement. The IRA is a tax-saving tool as the money you contribute to it is tax-deferred, only when you withdraw from it at the time of retirement is there a tax component, treating the income as capital gains. However, since the tax rates are lower after retirement there is not much tax burden on IRA withdrawals. The funds in the IRA account can be then directed by the contributor toward investing in different types of securities which are deemed permissible. There are different types of IRAs depending on the eligibility and requirements of the investor.
- Traditional IRA: Tax-deferred contributions over time, withdrawals are taxed after retirement.
- Roth IRA: The opposite of a traditional IRA plan, here the taxes are deducted from the contribution before it is put in the IRA and all withdrawals are tax-free at the time of retirement.
- SEP IRA : An employer can make contributions to a traditional IRA, instead of a pension fund, in the name of an employee.
- SIMPLE IRA: The employer in this case matches the contribution made by the employee towards IRA. SIMPLE stands for Savings Incentive Match Plan for Employees.
- Self-Directed IRA: This is an IRA where the investor makes investments on behalf of the retirement fund.
Investing in the Stock Market
Another way of investing money is the stock market. This is the riskiest option, though it has the potential for highest returns. Stocks are unit of shares which signify holding in companies which can be bought by individuals or other institutions. For example, a person can buy stocks in a company for $5 and the next day, the cost of the shares could be as high as $8 per share. Selling, it, he will make a profit of $3. The stock market may give returns of as much as ten to twelve percent annually, however, it is governed by the forces of demand and supply and affected by various factors, from national and international events to the minute economic changes that occur when the government tweaks financial policy. It is, therefore, not surprising that one may book profits in excess of 300% in a week’s worth of trading, or maybe lose the whole investment even quicker.
There are various options available for an investor in the stock market, some have been listed here according to their relevance for different types of investors.
The purest form of trading there is, trading stocks on the exchange requires skill, patience, insight and sheer guts. This is not for the faint at heart, or armchair investors who may not be serious about investing. If you have decided to take the traditional route to investment, by launching yourself onto the trading floor, it is best to have at least a few months salary safe in the bank. Always invest what you won’t immediately need, spread your risk but not too much, stick to blue-chip stocks if you want long-term returns and maintain a margin of safety while purchasing, whereas a chance to book profits while selling. Stocks are classified according to a variety of distinctions, each with its own advantages and disadvantages.
- Domestic stocks
- Sector based stocks
- Strategy based stocks
- International stocks
- Commodity stocks
- There are also stocks which may not be listed on the exchange such as Private equity and Venture capital stocks.
- There is immense flexibility; You can buy and sell stocks as you wish, or get a broker to carry out your transactions for you.
- The stock market gives better returns than most other forms of investment. When on a bull run, the returns can be many times your original investment, that too in a short period of time. During the bearish phase stocks can be bought cheap and held onto, till times change and the market moves upwards again.
- Stocks of companies from all over the world can be traded at the click of a button, this gives the investor a chance to diversify his investment and sniff out new sectors which are ripe for investment. The economic scenario in Asia might be better suited for certain companies than the recession hit economies of the West and it may be sensible to invest in companies that have Asia as a primary market.
- The stock market is a great leveler, it can change quickly and without warning wiping out big and little guys alike. As an investor, one must conduct meticulous research before going ahead and investing money, there should be a clear understanding of market conditions and an ability to forecast future movements with some certainty.
- There is an element of speculation present which can throw the best laid investment plans out of focus. The trading floor is abuzz with exchange of information and news, many times the general sentiment is influenced by the speculative activities of a few individuals and snowballs into affecting the whole market. At times like this, prices can fluctuate wildly causing serious harm to investors.
- You cannot sit back and relax once you begin investing in the stock market. Although brokers and commission agents will work for you, it does not mean one can leave the trading in their hands, after all, the decision to invest in particular sectors or stocks must be made by you.
Best picks for 2013
With a market cap of around $110 billion, Qualcomm is an attractive option these days. The financials of the company are robust too, with sales in the region of $20 billion and an asset base of $43 billion, it looks poised to perform well in 2013. It is trading upwards of $64 a share on NASDAQ.
The largest semi-conductor manufacturer in the world may be struggling to come to term with smartphones invading its PC space, however, a market cap of nearly $140 billion and revenues of $54 billion make this one heavyweight you shouldn’t miss out on. It is trading at about $21 on NASDAQ
The company that has innovation as its middle name, although many would argue otherwise in the post-Steve Jobs era, is an obvious contender for a bedrock investment. It is one of the largest companies in the world with $550 billion in market cap, $125 billion in revenue and the first position on the Forbes list of the World’s most powerful brand. It is trading in the range of $450 a share on NASDAQ.
United Parcel Service is set for a good year ahead as it has seen rising cash flows and its dividends have expanded, allowing the company to repurchase shares too. UPS has a market cap of $78 billion and is trading in the region of $82 a share on NASDAQ.
*As on 1/24/2013
Touted as the best investment solution for small investors, mutual funds are a collective investment tool, managed by professionals who invest in the stock market, creating portfolios of stocks, called funds, that are then sold to the general public as units. The Net Asset Value of a mutual fund changes according to the volume of units held by it at the end of every trading day. This is the figure at which one unit of the mutual fund can be bought by the public. Mutual funds can be either corporations or trusts, managed by a board of directors in the first instance and by a board of trustees in the second. Corporations are registered entities under the Securities and Exchange Commission (SEC) and managed by a fund manager. There are several types of mutual funds, they operate with different investment strategies and target different classes of investors.
Open-ended Funds: Such funds sell and buy shares from investors at all times, without any conditions. The securities held by the fund are also traded openly by the fund manager according to the market conditions.
- Closed-ended Funds: Such funds sell their units to the public only once and then the fund is closed. Selling back to the fund is not allowed and can only be traded with other investors on the market.
- Unit Investment Trusts: UITs also issue shares to investors once, however, they do allow the shares to be sold on the open market. They have a limited life-span and can be redeemed by the investor at the end of this term or sold earlier.
- Exchange Traded Funds: ETFs are set up as investment companies and are traded on the stock exchange like shares. Most ETFs today are index funds which track various equity or commodity indexes.
- Money market funds: A type of mutual fund that invests exclusively in US Treasury Bills and commercial papers, they are safer than normal open ended funds which trade on the market and since they are invested in short-term debt, they also have a measure of liquidity. The returns on money market funds is relatively higher than that from bank savings accounts.
- Collective investment lowers risk of abnormal losses.
- Professional advice and management of finances.
- Government regulation of investment practices reduces the risk of fraud.
- Easy monitoring of investment and liquidity.
- Investment in funds may require the payment of additional fees to advisors or the fund itself.
- Risk factor remains as the money is ultimately subjected to the vagaries of the stock market.
- No guarantee of returns, as prior performance is the only tool to judge the future performance of the fund, a fact which is by itself a disclaimer for such investment vehicles.
Best Picks for 2013
Vanguard International Growth
A good fund for investors looking overseas in turbulent markets, the Vanguard International Growth fund is a good option, with a Year-To-Date (YTD) return of 3.79%. The Net Asset Value (NAV) is $20.03 and the fund focus is on companies expanding globally and in markets which promise high returns in the coming years.
Contra funds typically invest in undervalued companies, with an aim to book profits when the share prices rise. The Fidelity Contrafund is a good performer with a YTD of 4.16% and a high NAV of $80.53.
American Funds American Balanced A
A large cap growth and income fund the American Funds American Balanced A, invests in blue-chip stocks which promise the growth of capital and good dividend income. It has an NAV of $21.18 and a YTD of 3.53%.
*As on 1/24/2013
Real Estate Investment Trust – REIT
Another popular investment vehicle for investors keen on getting into the real estate market are Real Estate Investment Trust (REIT) stocks. They are traded like normal stocks on the exchange but they invest their funds exclusively in real estate properties and mortgages. They are categorized as follows.
- Equity REITs: Investment is made in physical properties, either owned or via a mode of investment. The income is given to the holders of REITs from the rent they receive from these properties.
- Mortgage REITs: The primary investment happens in property mortgages, purchase of mortgaged securities and even loaning money to mortgage-holders. Income is earned through mortgage interest.
- The REITs offer high returns to investors.
- Tax-treatment for REIT income is fairly straightforward
- Adding REITs to your portfolio can help in diversification.
Real estate as a sector goes through various ups and downs, this may translate to fluctuations in the dividend income REITs can offer.
Gold and Precious Metals
Gold is proving to be a very healthy investing option these days. Even historically, bullion prices have always appreciated with time. Gold and other precious metals like silver and platinum are safe harbors where you can park your money and ensure its growth, even during an economic recession. You may invest in gold directly or indirectly through exchange traded funds and other instruments.
Best Picks for 2013
Newmont Mining Corp
Newmont owns gold mines in various parts of the world, from New Zealand to Ghana. They are one of the big gold producers and buying stock will definitely help you enter the gold bullion segment. It has revenues touching $10 billion and is the only company mining gold, to remain in the Standard & Poor’s 500 Index. It is trading at around $44 on the NYSE.
SPDR Gold Trust (ETF)
An exchange traded gold fund, the SPDR Gold Trust is also a good option for investors who may be wary of investing in straight stocks of mining companies. It has a market price of around $161 on the NYSE Arca.
*As on 1/24/2013
This was a look at some of the best ways to invest this year, there are of course other avenues of investments such as derivatives and venture capital, which can be explored by mature investors, although they have much higher elements of risk involved. One can also invest in oneself, by joining a course on a subject of choice, or maybe enrolling for a degree program. Investing can also be done by putting up money for a fledgling business enterprise, helping it grow and reaping the rewards later. However, before going ahead with your investment plans, take some time to establish your long-term financial goals, assess the degree of risk you are willing to take and then chart an investment route for the future.