Introduction to Investment

Opening Case

After years of hard work, Ben found himself having excess cash in his
funds. He has been saving for a rainy day; he does not really have anything he
is saving for. However, realizing the amount that he had, he came to a resolution
that he wanted to make his money work for him. Ben wished to earn from his
extra money, so that he could save more for his future. Or if the need arises, he
will be able to shell out the money needed. What should Ben do with his money?

Introduction

In this chapter, we are going to take a look at the different opportunities

open for people like Ben. Simply put, these additional earning opportunities or
resources are what we call investments. Investments help us earn apart from
the usual work that we do. They also help us exercise our business and
entrepreneurial skills, because investments help us be keener about the
different business opportunities that are available around us.
It is not always enough for a person to have enough cash or assets in his
coffers; part of being financially mature is having that careful observation and
being able to grab different opportunities to earn. This means that he will be
able to maximize his wealth more if he is able to earn in other business
opportunities, even if they are outside his main line of business... more so if the
opportunities grabbed are outside of his main line of business or jobs.
One popular way to maximize wealth is through investments. Investments
are assets that earn passive income. Basically, passive income is an inflow of
resources, more often money, which required very little effort from the person
who earned it. Investments help us earn more, and hence expand our personal
wealth, apart from our main business. Not only do investments help us produce
more capital, it also helps us exercise our business skills as well.
So you ask, how can a person earn without much effort from investments?
Investments can earn dividends, interest, rents, and other income. We're going
to have a run down on the list of the common investments that we should know.
But before that, here are a few reminders regarding investments.
What You Need to Know

Investment opportunities should be grabbed only when you have extra

resources available for such. Just because there is an opportunity does not
always mean that it should be grabbed. Such opportunities should only be taken
when you can. If you are merely operating within your means, learn to prioritize;
investments can take a back seat first. After all, these opportunities are not
always once in a lifetime. If you missed one today, you can grab the next one
soon enough. You just need to keep your eyes open.
Investments should not be your main source of income. Unless you are a
stock broker, an insurance salesman, or all investment banker, you should not
heavily rely on the income coming from your investments. One good reason for
it is that your investments generate income and/or cash flows that are largely
independent from your main line of business. Again, prioritize; if you have your
main line of business or work, focus on it. Aside from that, income from
investments is not that regular; they fluctuate. Heavy reliance on the inflows
coming from these assets would create a 'feast or famine' condition. This means
that by heavily relying on the resources that these assets might generate, given
that they do not produce regular cash flows, might make you very prosperous
one moment and then very unfortunate the next.
Investments require additional risk-taking. Investments are quite a risky
asset, so a person planning to invest must be able to learn how to take risks.
Actually, it is from these risks that the investor earns.
What are the different types of investments? We can classify them into
these following categories: deposits, funds, bonds and stocks, and hard assets.
Let us go through each category one by one.

Deposits

The first type of investment that we would take up can generally be termed
as deposits. These types of investments basically pool the resources of a
person– the depositor to a certain account, which may be withdrawn sometimes
in the future. The deposit may be made regularly or just when the need arises.
Then availability of the funds also depends on the investments that we open.
Bank deposits are money placed in a bank for safekeeping. This is the
most common type of investment. For business, maintaining a bank account is
the norm; for individuals, maintaining a bank account is highly encouraged. The
most common types of bank deposits are as follows: current account, savings
account, and time deposit account.
Current account, also known as a checking account, allows a person to
draw checks whenever withdrawals are made. What is good with maintaining a
current account is that the bank normally gives a bank statement to the
depositor at regular intervals, usually at the end of each month. Bank statements
present the deposits and withdrawals made by the depositor for the current
period. This allows the depositor to monitor his balance in the bank. Another
advantage of maintaining a current account is that the money we have
deposited in the bank is secured. Larger banks are secured by the Philippine
Deposit Insurance Corporation or PDIC. The PDIC guarantees that part of our
deposit made with the bank is secured, so if ever the bank runs out of funds and
needs to dose down, the PDIC guarantees that we will still be able to recover
our deposit. However, current accounts normally do not earn interest, so there
really is no income accruing to the depositor when he maintains a checking
account. Current accounts do not earn; they are merely for safekeeping of our
money.
Savings account earns interest, but not that significant. Normally, these
types of accounts earn less than 1% annually. Savings deposits are more
common among individuals. These are represented by cards given by
shareholders. These cards are normally called debit cards. The main advantage
of maintaining a savings account is that in times of emergency, the presence of
the card can be presented as an instant payment to be deducted directly from
the depositor's account without the hassle of queuing up to get cash from an
automated teller machine (ATM). Savings account is a good way for us to start
when we plan to invest. It is highly recommended for a person to maintain a
personal savings account because from the term itself, this type of bank deposit
helps us save money to be used in the future.
Time deposit accounts earn the highest interest among the three bank
accounts that we mentioned, the interest increasing as the term gets longer.
Time deposit accounts can have a term as short as three months, and as long
as ten years. Time deposits earn income in the form of interest. Interest is the
passive income earned on debts of the counterparty. However, unlike current
and savings accounts, time deposit accounts are not always available for
withdrawal. The depositor needs to wait for a certain period before the money
deposited and earned in the account be made available for withdrawal.
Time deposit accounts are evidenced by a certificate of deposit, which can also
be bought and sold by the depositors themselves. Certificates of deposit are a
contract evidencing the time deposit that we have They are usually transferrable,
meaning if we do not intend to hold our time deposit any longer, but we cannot
withdraw anything from it because of the agreement with the bank, we can sell
these contracts, and the buyer now will be the 'owner' of the time deposit
account.
Funds

Insurance are accounts set up for some specific purposes at some future date.
There are set up as a protection against any losses that might happen in the
future. For example, entities set up insurance for the unexpected loss or death
of their key management personnel, so that if ever that unfortunate event
happens, the entity might still be able to get something out of it. We can insure
our houses so that if ever something undesirable happens, we would not have
to dish out a lot of money to build another house to replace it. Insurance is not
deposits, although they require regular payments from the individual or the
company.
The main advantage of maintaining insurance is the assurance of cash
receipt upon the occurrence of the condition. For example, we can subscribe to
a health insurance. Given that, we need to pay a certain sum of money regularly,
usually every month. This regular payment is what we call premium. Health
insurance allow us to be admitted to a hospital or health clinics, and then pay a
little or no fee at all, provided that such institutions acknowledge the health
insurance that we are subscribing.
On the other hand, insurance do not really earn per se. They do help us
decrease our disbursements, like medical expenses in the example that we had
earlier, but the premiums that we pay do not earn any interest or other types of
passive income. The premiums merely say that we are maintaining our account
with the insurance company.
Mutual funds operate like a time deposit account, but the one who keeps
or takes care of our account is not always the bank; they can be a mutual fund
company, an investment bank, or an individual that we call a broker. Mutual
funds require the payments from the client (regular or discretionary), and the
growth or interest already fixed by the fund itself. What happens in mutual funds
is that our deposit will be invested in a diverse range of portfolios or any other
investments made by the professional broker or the company from which the
client will be able to earn income without going through the process of studying
which types of other investments to put his money in. The returns produced by
such funds are given by the broker to the client, less any payments applicable,
of course.
Mutual funds can be short- or long-term. The main advantage of
maintaining a mutual fund is that it allows us to earn more compared to any
other deposits, without the burden of thinking which investment opportunities
we should consider. But one of its disadvantages is that if the client chose a
weak broker, chances are he might lose his money because wrong investment
decisions made by the broker might entail giving up the cash paid by the client.
Bonds and Stocks

Bonds are investments that allow the holder to earn regular payments in the
form of interest from the issuer. These financial instruments are a liability of the
holder, and obviously an asset of the holder. Bonds are long-term investments
that pay regular interest payments, and from which the principal amount is due
when it matures. Compared with stocks (which will be discussed later) bonds
are less risky, mainly because they have a maturity. But parties who plan to
invest in such securities must be careful. Make sure to study the background of
the issuing company first before buying their instruments. A potential investor
or buyer of the bonds should know about the credit rating of the issuer, which
basically summarizes the riskiness inherent in the issuing company. Usually,
the higher the interest rate stated in the bonds means that the instruments are
riskier. More risks entail a larger probability of the principal not getting paid by
the issuing company. Still, compared with other interest-bearing investments
like current and time deposit accounts, bonds do earn more.
Stocks most probably are the most famous form of investment. These
instruments represent an ownership in the issuing company. Unlike bonds that
represent a liability of the issuer, stocks represent ownership. One main
advantage of stocks is that it allows us to have a 'power' over the issuing
company. The holder of the stocks, whom we call the stockholder, does have
voting powers in the company, depending upon the percentage of his holding.
Of course, the higher the holdings, the higher the voting power, the greater
influence of the stockholder over the company. But the holdings depend on the
investor. If the investor would only want payments arising from the stocks,
termed as dividends, which are declared by the board of directors of the
company, representing the returns on the investment of the stockholders, a
small percentage of holdings may suffice. Dividends depend on the number of
stocks we hold. The more stocks that we own, the more dividends that we can
receive. Still, we have to take note that unlike bonds, dividends are not regularly
given. It is the company's decision if it is going to pay dividends to its
stockholders or not. But if the stockholder would want to exercise his influence
over the issuing company, it would be advisable if he buys more of the
company’s stocks.
Another goal investment strategy with stocks is to monitor the changes of
its price in the market, but this would only apply in stocks that are traded in the
Philippine Stock Exchange. If the investor would want to take advantage of the
changes in the price of the stocks, then what he could do is to buy stocks, wait
for it to increase (prices of stocks in the exchange fluctuate by the minute), then
sell it immediately once it does, simply put as `buy low sell high' strategy. The
main problem with this strategy is that the investor needs to monitor the stocks
closely, which would probably take a toll on him, at this would take a significant
amount of time. And not just that, the short-term profits that might be realized
from the short-term fluctuations of the price of the stocks may sacrifice the mid-
or long-term increases in the price of stocks. Whatever the investor intends
regarding his investment in stocks, just like when he plans to invest in bonds, is
to take it a good look at the background of the issuer as well. A good company
would pay dividends regularly, and its stocks would probably not fluctuate that
much.

Hard Assets

Hard assets are tangible assets used as investments. Instead of using other
intangible investments to earn passive income, tangible assets like buildings
and land can be used to expand the wealth of the investor even more. While the
previous investments discussed above may earn interest and dividends, hard
assets produce more wealth to the investor through rents. So as we can are
buildings, lands and any other assets are not merely for the main business
operations of the company, they can also be used to earn other income largely
independent of the income produced in our main line of business or job. If the
location of the property is good, then it would earn great amounts of rent (if it is
a building) or significant capital gains (if it is a piece of land).
However, investing in such properties require a lot of extra money,
because buildings and tracts of land do not come cheap. Another disadvantage
of investing in hard assets, such as real estate, another term for properties, is
their illiquidity, or their inability to be turned into cash immediately. So when we
need cash immediately, say when emergency arises, chances are we might not
be able to sell the land or building immediately. Another disadvantage of
investing in real estate is the fluctuation in prices. The prices of real estate
properties are quite difficult to predict, no we have to make sure that the property
that we plan to invest in has good characteristic. good location and environment,
among others. Like all other forms of investment, real estate investment has its
risks—many financial experts see the real estate industry in the United States
as one of the main culprits in the financial crisis that they experienced back in
2008.

Where to Invest

There are a lot of opportunities available fort person or a company to invest its
extra cash or other resources. But before buying an investment, certain factors
must be considered.
Firstly, the amount of extra cash available should be considered. The
investor most obviously invest within his means. And not just that, not all of his
extra resources most be used to buy investments, because there will always be
circumstances in which each will be needed in case of emergency. Secondly,
the risk inherent in the investment should be taken into account. Higher risk
entails higher return, but the question is if the investor is willing to take that
amount of risk. Deposits are the least risky investments, but they earn the least,
too. Real estate investments do earn a lot, but they are so risky that they could
even cause a national economy to crash. So, it depends upon the behavior of
the investor in which investment to buy.
Not only that, we must be able to manage the risk involved in the
investments that we are planning to buy. We must not put all our money in one
investment, so as to spread or diversify our risk. The good thing with managing
risk. or diversifying our investment, is if ever we are not successful in one of the
investment opportunities that we grabbed, we will still have other investments
left which would still help us earn.
Lastly, we should consider our intent. We should ask ourselves if the intent
is short term or long term, because that would greatly influence the kind of
investment that we need to buy. If we would like to earn for a shorter term,
maintaining a short-term time deposit account is enough. We could also
purchase some stocks, and then immediately sell them if the price increases.
Stocks and bonds can also be held as long-term investments. Bond pay regular
interest, and stocks do earn dividends. Another long-term investment available
is hard assets, from which we may earn rent.

Key Terms

Bank statement Hard assets Real estate

Bond Insurance Saving account
Certificate of deposit Interest Stock
Current account Investments Stockholder
Debit card Mutual fund Time deposit
Deposit Passive income
Dividend Premium