INVESTING FUNDAMENTALS

The word "investment" has become muddled with overuse. Referring to a

stock or a bond as an investment is still in regular use, but now people make
"investments" in their education, their cars and even their flat screen TVs.
In this article, we will look at the three basic types of investment as well as some of
the things that are definitely not investments - no matter what the commercial
says.
Investment, as the dictionary defines it, is something that is purchased with
money that is expected to produce income or profit. Investments can be broken
into three basic groups: ownership, lending and cash equivalents.
1. OWNERSHIP INVESTMENTS are what comes to mind for most people when the
word "investment" is batted around. Ownership investments are the most volatile
and profitable class of investment.
The following are examples of ownership investments:
 Stocks
 Business
 Real Estate
 Precious Objects

Stocks are literally certificates that say you own a portion of a company. More
broadly speaking, all traded securities, from futures to currency swaps, are
ownership investments, even though all you may own is a contract. When you buy
one of these investments, you have a right to a portion of a company's value or a
right to carry out a certain action (as in a futures contract).
Your expectation of profit is realized (or not) by how the market values the asset
you own the rights to. If you own shares in Sony and Sony posts a record profit,
other investors are going to want Sony shares too. Their demand for shares drives
up the price, increasing your profit if you choose to sell the shares

Business
The money put into starting and running a business is an investment.
Entrepreneurship is one of the hardest investments to make because it requires
more than just money. Consequently, it is also an ownership investment with
extremely large potential returns. By creating a product or service and selling it to
people who want it, entrepreneurs can make huge personal fortunes. Bill Gates,
founder of Microsoft and one of the world's richest men, is a prime example.
Real Estate
Houses, apartments or other dwellings that you buy to rent out or repair and resell
are investments. The house you live in, however, is a different matter because it is
filling a basic need. The house you live in fills your need for shelter and, although it
may appreciate over time, it shouldn't be purchased with an expectation of profit.
The mortgage meltdown of 2008 and the underwater mortgages it produced are a
good illustration of the dangers in considering your primary residence an
investment.
Precious Objects
Gold, Da Vinci paintings and a signed LeBron James jersey can all be considered an
ownership investment - provided that these are objects that are bought with the
intention of reselling them for a profit. Precious metals and collectibles are not
necessarily a good investment for a number of reasons, but they can be classified
as an investment nonetheless. Like a house, they have a risk of physical
depreciation (damage) and require upkeep and storage costs that cut into eventual
profits.
2. LENDING INVESTMENTS
Lending investments allow you to be the bank. Lending Investments tend to be
lower risk than ownership investments and return less as a result. A bond issued by
a company will pay a set amount over a certain period, while during the same
period the stock of a company can double or triple in value, paying far more than a
bond - or it can lose heavily and go bankrupt, in which case bond holders usually
still get their money and the stockholder often gets nothing.
Examples of lending investments
Your Savings Account
Even if you have nothing but a regular savings account, you can call yourself an
investor. You are essentially lending money to the bank, which it will dole out in
the form of loans. The return is pitiful, but the risk is also next to nil because of
the Federal Deposit Insurance Corporation (FDIC). (PDIC in Phils.)
Bonds
Bond is a catchall category for a wide variety of investments from Treasuries and
international debt issues to corporate junk bonds and credit default swaps (CDS).
The risks and returns vary widely between the different types of bonds, but overall,
lending investments pose a lower risk and provide a lower return than ownership
investments.
3. CASH EQUIVALENTS
These are investments that are "as good as cash," which means they're easy to
convert back into cash.
Short term highly liquid financial instruments that are so near their maturity and
that there is insignificant risk of change in value due to fluctuation of interest rates.
Only highly liquid investments that are acquired three months before maturity can
qualify as cash equivalents.
Examples: 3-month BSP Treasury Bill, 3-month Time deposit, 3-month money
market instrument or commercial paper.
CASH EQUIVALENT- matures 3 months or less from the date of acquisition.
SHORT TERM/TEMPORARY INVESTMENT- matures less than 1 year from the date
of acquisition.
LONG TERM INVESTMENT- matures more than 1 year from the date of acquisition.
“Temporary investments in equity shares are not included as part of cash
equivalents because these securities do not have maturity dates. Except for
Redeemable Preference share(considered as debt instrument), it can be reported
as cash equivalent if purchased within 3 months or less before redemption date.”

EXAMPLE OF CASH EQUIVALENT

Money Market Funds
With money market funds, the return is very small, 1% to 2%, and the risks are also
small. Although money market funds have "broken the buck" in recent memory, it
is rare enough to be considered a black swan event. Money market funds are also
more liquid than other investments, meaning you can write checks out of money
market accounts just as you would with a checking account. (For more on black
swan events, see Black Swan Events and Investing.)

Close, but Not Quite

Your education is called an investment and many times, it does help you earn a
higher income. A case could be made for you "selling" your education like a small
business service in return for income like an ownership investment.
The reason it's not technically an investment is a practical one. For the sake of
clarity, we need to avoid the ad absurdity of having everything be classified as an
investment. We'd be "investing" every time we bought an item that could
potentially make us more productive, such as investing in a stress ball to squeeze
or a cup of coffee to wake you up. It is the attempt to stretch the meaning of
investment to purchases, rather than education, which has obscured the meaning.

Not Investments
Consumer purchases - beds, cars, TVs and anything that naturally depreciates with
use and time - are not investments. As an example, you don't invest in a good
night's sleep by buying a foam pillow. Unless you're very famous, and even then,
it's a stretch, since you can't reasonably expect someone to pay more for your
pillow than the initial purchase cost. Don't take it personally, but there's very little
demand in the second-hand pillow market.

5 INVESTING RISK FACTORS AND HOW TO AVOID THEM BY TIM PARKER

Investing comes with risks. Sometimes those risks are minimal, as is the case
with treasury bonds, but other times, such as with stocks, options and
commodities, the risk can be substantial. The more risk the investor is willing to
take, the more potential for high returns. But great investors know that managing
risk is more important than making a profit, and proper risk management is what
leads to profitable investing.

Each investment product has certain risks that come with it, while some risks are
inherent in every investment. Here are a few to consider.
Business Risk
Business risk may be the best known and most feared investment risk. It's the risk
that something will happen with the company, causing the investment to lose
value. These risks could include a disappointing earnings report, changes in
leadership, outdated products or wrongdoing within the company. Because of the
large amount of possible risks that come with owning stock in a company, investors
know that forecasting these risks is nearly impossible.

Purchasing a put option to guard against a large decline or setting automatic stops
are the best ways to guard against business risk
Call Risk
Some bonds have a provision that allows the company to call back or repay a bond
early. They will often exercise this right if they have to pay a higher coupon on an
existing bond than what they would have to pay at today's interest rates. Although
this will not represent a loss of principal, for investors who rely on a certain coupon
rate for their monthly living expenses, this can represent a substantial loss of
income.

For those who rely on coupon income for immediate living expenses, investing
in non-callable bonds, bond funds or exchange traded funds is a
solid diversification strategy

Non-callable bond is A financial security that cannot be redeemed early by the

issuer. The issuer of a non-callable bond subjects itself to interest rate risk because,
at issuance, it locks in the interest rate it will pay until the security matures.

Allocation Risk
Have you looked at your 401(k) lately? You've likely heard that keeping the
appropriate asset allocation is essential to managing risk as you move closer to
retirement. Moreover, this summer, federal disclosure rules are requiring 401(k)
providers to disclose fees associated with investment products.
The younger you are, the more of your portfolio should be allocated to stocks and
as you age, bonds will slowly become the dominant investment type. Manage your
allocation risk and fees related to investing in your retirement account by investing
in a low-fee target date fund. Additionally, ask for the help of a trusted financial
adviser if you don't have the knowledge or experience to manage your own
portfolio.

Political Risk
Investors in commodities like oil understand political risk. When Iran threatened to
block the Strait of Hormuz, investors were concerned that the price of oil would
become more volatile, putting their investment at risk. The Haiti conflict and
terrorist attacks on oil pipelines have caused artificial volatility to enter oil and
other commodity markets. Moreover, issues arising in South East Asia pertaining
to land claims, as well as the tensions between North and South Korea, have shaken
markets in that region.

Socio-political risk is difficult to avoid since most events happen without warning,
but having hard and fast exit points as well as hedges are the best way to weather
socio-political storms.

Dividend Risk
Dividend risk is the risk that a company will cut or reduce its dividend. This is not
only a problem for those who rely on stock dividends to live on during retirement,
but when a company cuts its dividend, it often causes the stock to lose value, as
those who were holding it for the dividend move to other dividend-paying names.
Reduce the effects of dividend risk by holding a well-diversified portfolio with
multiple dividend-paying stocks. If the dividend is the only reason you're holding
the stock, sell as soon as is practical after the announcement of the change.

The Bottom Line

Every investing strategy will have risks and managing those risks is how to gain the
best performance from your money. Don't reach for higher rewards without first
evaluating the risks involved. Seasoned investors know that it's a lot easier to lose
money than it is to gain it.

Money management philosophies

Financial fitness, like physical fitness, is mostly about good habits. “You’re
establishing habits and getting into a routine at an early age,” says Mary Beth
Storjohann, certified financial planner and CEO and founder of Workable Wealth.
“So as your income grows and your life gets more complicated as you get older,
you’re already in the routine of setting money aside, tracking your spending, saving
for retirement and you know how to shape and plan for goals.”
Here are three habits to adopt now for financial health:
1. Spend less than you earn.
This principle is at the core of all good financial management. It’s how rich people
get rich. It’s how people who aren’t wealthy can achieve their life goals anyway,
without scads of money to throw around. When you spend less than you earn, you
save. And what you save becomes wealth.
[This principle] is what makes people not worry about money, because they know
they can pay their bills every month, and if an emergency comes up, they know
they have enough in savings. People who spend more than they earn are going
further and further into credit card debt or going into their overdraft, and that
creates a ton of stress,” says Sophia Bera, certified financial planner and founder
of Gen Y Planning.
This was key for me to climb out of debt, stay out of debt, build up my savings and
achieve life goals like quitting my job to freelance, living in Italy for four months,
moving to a new city and more.
No matter how wealthy or poor you start out as an adult, this is the secret to
maintaining a life of freedom to pursue your goals. The wealthy, if they live beyond
their means, lose their riches, and the poor, if they do the same, will never escape
poverty. While the other two primary financial principles will make your life a lot
easier, this one makes or breaks your life, period.

2. Invest as early as you can.

Everyone’s biggest financial challenge is saving for retirement. It’s the largest
amount of money you’ll have to save in your lifetime, and unpredictable windfalls
notwithstanding, the only way to accomplish it is to save regularly over a long
period of time. But if you start to save early on in your career, the prospect
becomes less daunting.
Saving at a young age allows you to take advantage of the power of compounding.
If Person A saves $5,000 a year from age 25 to 40 for a total of $75,000 and then
never invests another penny, and Person B invests $5,000 every year from 40 to 65
for a total of $125,000 invested, assuming 5% growth, Person A will end up with
more than $400,000 by retirement, while Person B will only have $256,000, simply
because Person A started saving earlier, even if she put away less.
“The earlier you start investing, the longer your money is in the market, hopefully
giving you a return in the market, beyond inflation, to set you up for an income
stream in retirement,” says Storjohann. “You’re in an accumulation phase for the
next 30-35 years, and you want your money to grow, because when we’re 65, that’s
when we have to turn on the spigot, and all of our funds have to turn into a
paycheck replacement for us. We’re building up one large pot to give us a paycheck
for the rest of our lives.”
So if you want to make saving for retirement a whole lot easier for yourself, start
now, if you haven’t yet. Your mind is probably whirring with excuses at this point—
how you really need the money now, how you’ll start when you make more money,
how you can get to it later—but the truth is, there will always be an excuse. When
you get a raise, you may want to save for a house, or maybe you’ll want to save for
a wedding or to have kids, or save for their college education. There will never be
an optimal time to start saving for retirement. You will always have to do it against
competing priorities. So learn to do it at the same time as these other demands on
your life. Then, when you’re 65 and you want to retire, you’ll be so glad you have
enough money to live a comfortable life for the next few decades. If you don’t, then
at 55 you may be facing a layoff with a modest nest egg, and you’ll be cursing your
younger self.
3. Earn more.
[Earning more] solves multiple problems,” says Bera. “If you’re used to making
$2,000 a month net income from your day job but you’re able to do part-time work
freelance or pick up extra hours on the weekend, that’s all extra. That’s above and
beyond what you’re already making, so if you’ve already figured out your monthly
expenses, let’s say you’re making $500 extra a month—that’s money that can go
to pay down debt quickly or build up savings fast.” Or, you could use that money to
go on a trip or save for a down payment on a home.
Beyond that, earning more has a cumulative effect. The earlier you start making
more money, the larger your future raises will be , since raises tend to kick in as a
percentage of your existing salary, which means more money over your lifetime.
“The earlier you can lock in the higher income, the better,” says Storjohann,
“because it’s more money you can set aside for your future as well.”
For me, earning more, which I began to do in my last full-time job by taking on an
extra, regular freelance gig, was also key to getting myself on the right path
financially. Not only did it allow me to pay off my student loan debt in about a third
of the duration of my loan repayment plan, but it also allowed me to accrue enough
savings for me to feel comfortable quitting full-time work. Scrimping and cutting
costs only go so far, but an extra $200, $500 or $1,500 a month goes a lot further.
It's remarkable to look back and think that just four years ago I owed thousands on
my credit cards, didn't have a savings account in my name and had never created a
budget. Today, I have no debt, a comfortable amount of savings, a growing
retirement nest egg, and I'm still able to afford things that really matter to me, like
going to a friend's wedding in Turkey. I somehow even wrote a personal finance
and career book. To what do I owe my transformation? These three money
principles.

TEN PRINCIPLES THAT FORM THE BASICS OF FINANCIAL MANAGEMENT

Principle 1
The Risk–Return Trade-Off—We Won’t Take On Additional Risk Unless We Expect
to Be Compensated with Additional Return
Principle 2
The Time Value of Money—A Dollar Received Today Is Worth More Than a Dollar
Received in the Future
Principle 3
Cash—Not Profits—Is King
Principle 4
Incremental Cash Flows—It’s Only What Changes That Counts
Principle 5
The Curse of Competitive Markets—Why It’s Hard to Find Exceptionally Profitable
Projects
Principle 6
Efficient Capital Markets—The Markets Are Quick and the Prices Are Right
Principle 7
The Agency Problem—Managers Won’t Work for the Firm’s Owners Unless It’s in
Their Best Interest
Principle 8
Taxes Bias Business Decisions
Principle 9
All Risk Is Not Equal—Some Risk Can Be Diversified Away, and Some Can Not
Principle 10
Ethical Behavior Means Doing the Right Thing, but Ethical Dilemmas Are
Everywhere in Finance

Earning, Spending, And Saving: The Building Blocks Of Personal Finance

A couple of weeks ago, Robert Brokamp explained how living below your means is
like saving for retirement twice. On the surface, his advice was pretty conventional:
The more you save today, the more you’ll have tomorrow. This is similar to a point
I’ve been repeating for the past five years.
Smart personal finance can be reduced to one simple equation:
[WEALTH] = [WHAT YOU EARN] – [WHAT YOU SPEND]
If you spend more than you earn, you have a negative cash flow. You’re losing
wealth and in danger of going into debt. (Or, if you’re already in debt, you’re digging
the hole deeper.) If you spend less than you earn, you have a positive cash flow,
which will let you climb out of debt and build wealth.
But as I was editing Brokamp’s article, I had a flash of insight. What Brokamp was
trying to say — and what my little equation tries to quantify — is that basic personal
finance comprises three essential skills:
Earning — your ability to bring in money.
Spending — your ability to live frugally and spend wisely.
Saving — your ability to produce a surplus and to make that surplus grow.
Some folks are good at one skill, but not the others. (Maybe you’re good at keeping
your costs low, for instance, but struggle to earn money.) Other people are good
at two of the skills, but fall down on a third. (You might have a good income and
keep your costs low, but have a small nest egg because you lack skill in saving.) And
still others are passable at all three skills — not really excelling, but not failing
either.
To be truly successful at personal finance, you have to maximize your performance
in all three areas.
Mastering the Art of Earning
Here are some steps that lead to increased earning:
Become better educated. In general, the better your education, the better your
income.
If possible, choose a career that you love — and that pays well. This isn’t always
possible, of course. But if you can get paid well to do what you love, it can almost
be like you don’t have a job at all!
Maximize your salary. This is probably your primary source of income, so make the
most of it. Learn how to negotiate your salary. Make the most of your benefits.
Make money from your hobbies. Find ways to earn a little cash from the things you
do in your spare time.
Turn your clutter into cash. When I was getting out of debt, I sold tons of Stuff
previously bought on credit. I didn’t get back what I paid for it, but that’s okay. I got
out of debt, which was even better. (Here’s more about selling your stuff.)
Though some people don’t like to hear it, high income is also associated with hard
work. The folks who make the most money are often those who work the longest
hours. Hard work doesn’t guarantee a high income, of course — there are plenty
of hard workers stuck in low-wage jobs — but it’s tough to master the art of
earning withouthard work.
And here’s another reason to enhance your earning power: As vital as it is to cut
your spending, there’s only so much you can trim from your budget. Your income,
on the other hand, is theoretically unlimited.
If life were a game, your earning score would be easy to calculate: It’d simply be a
measure of your annual income. The more you made, the higher your score.
Note: For more on this subject, see my colossal post about how to make money.
It’s a huge list of ways to boost your income.
Developing Discipline in Spending
While some people find it tough to boost their incomes, others find it tough to keep
costs down. There are even those who believe that thrift is overrated, that it’s
somehow akin to deprivation. But those who dismiss frugality to focus solely on
earning are missing a key piece of the puzzle. Your goal should be to create as big
a gap as possible between earning and spending.

How do you do that?

Embrace frugality. A lot of folks are afraid to pinch pennies — they don’t want to
appear cheap — but frugality is an important part of personal finance. Learn to clip
coupons, shop at sales, and make do with less.
Practice conscious spending. You can’t always get what you want, so decide what’s
important to you, and make those things a priority. Cut corners on the things that
don’t matter.
Avoid paying interest. The power of compound interest can help you build wealth
when it’s on your side. But it can suck you dry if it’s working against you. To cut
your interest payments, Get out of debtand stay out of debt. Make it a goal to pay
as little interest as possible.
Reduce recurring expenses. One-time costs can be painful, but ongoing expenses
— like magazine subscriptions, cable television and cell-phone bills, etc. — can act
like an anchor on your finances.
Focus on the big wins. Daily frugality is a valuable skill. It helps you save a little bit
all the time. But if you really want to cut your spending, spend less on the big
things, like housing and transportation.
If personal finance were a game, your spending score would come from how low
you could go. The less you spent, the higher your score.

Remember: Your earning power might bring you wealth; frugality and thrift will
help you keep it. By cutting your spending while you increase your income, you’ll
develop a cash surplus — a surplus that can be used for saving.
Note: For some reason, financial writers often fixate on spending. There’s no
question that it’s important, but it’s not the only piece of personal finance. It’s one
of three basic building blocks. If you embrace frugality but ignore your income and
investments, you can’t expect to build wealth. Each skill is essential.
Discovering the Secret of Saving
Often when I write about saving, I’m just talking about the difference between what
you earn and what you spend. This surplus is important, no question — it forms the
foundation of your ability to save — but skill at at saving comes mainly from what
you do with your surplus.
If you hide your money under a rock, for instance, your skill at saving isn’t
particularly good. Anyone can do that. And though you might think you’re
protecting what you’ve saved, you’re actually losing money to inflation, the silent
killer of wealth. (If you use your extra money to play the lottery, I’d argue that your
savings skills are especially poor!)
What sorts of things go into becoming a successful saver? This is where a
knowledge of investing pays dividends. The secret of saving is to learn everything
you can about making your wealth grow. Successful savers:
Understand the importance of creating a plan — and sticking to it. (This is
where asset allocation and re-balancing come into play. I’ll write about these more
later in the month.)
Make logical decisions instead of succumbing to emotion. Successful savers don’t
make decisions based on breathless media pundits.
Avoid fads. They don’t buy real estate just because everyone else is. They don’t buy
tech stocks just because they’re riding high. And they’re wary of gold when it’s at
record highs. They buy low and sell high.
Embrace diversification as a way to improve returns while reducing risk.
Constantly contribute their surplus income to grow their savings. They pay
themselves first.

If there were a scorecard for life, your points for saving would be determined by
how much you make your surplus grow, and by how well you protect the money
you save.
Note: I used to do a poor job with all three of these skills. Over the past few years,
I’ve become adept at earning, and I’m learning to be a better saver. My spending
skill is improving, but remains the weakest part of my personal-finance package.

The Fundamentals of Personal Finance

None of this is earth-shattering; these notions form the core of smart personal
finance. What is new — for me, anyhow — is thinking of earning, spending, and
saving as discrete skills, building blocks that can be put together to form a greater
whole. It’s this framework that’s new.
Mastering money means mastering each of these three skills
If you can teach yourself all about earning, spending, and saving — and put what
you learn into into practice — you’ll achieve your financial aims with surprising
speed. But so long as one of these skills lags, you’ll struggle to meet your goals.