Investing is the act of putting your money into something that can generate more money over time. For example, you can invest in stocks, bonds, real estate, or businesses. Investing can help you create passive income, which is money that you earn without working actively. Passive income can supplement your regular income and help you achieve your financial goals faster.
Why should you invest?
To grow your wealth: Investing can help you increase your net worth and build your financial security. The more you invest, the more money you can potentially make from the returns on your investments.
To beat inflation: Inflation is the rise in the prices of goods and services over time. It reduces the purchasing power of your money. Investing can help you preserve or increase the value of your money by earning a higher rate of return than the inflation rate.
To save for retirement: Investing can help you prepare for your future and ensure that you have enough money to live comfortably when you stop working. You can take advantage of tax-advantaged accounts and compounding interest to grow your retirement savings.
To achieve your financial goals: Investing can help you fund your short-term and long-term goals, such as buying a house, paying for education, traveling, or starting a business. You can choose different types of investments that suit your risk tolerance and time horizon.
You should start investing as soon as possible, because the earlier you start, the more time you have to benefit from the power of compounding. Compounding is when your earnings from your investments are reinvested to generate more earnings. This way, your money grows exponentially over time.
How Does Investing Work?
Investing works by putting your money into assets that can generate income or appreciate in value over time. You can either buy or sell these assets depending on their performance and market conditions. There are two main ways to make money from investing:
Capital gains is when you buy low and sell high. In investing jargon, this is when you sell an “asset” for more than what you paid for it. An asset can be a piece of property like a house, a share in a business (a stock), it can also be a painting, a vintage car, or anything of value that a person or an organization owns.
In capital gains, you’ll make money from the difference of how much you paid for something and how much you sold it for. For example, if you buy a piece of real estate for ₱1 Million and sell it for ₱1.5 Million, you have a capital gain of ₱500,000. On the flip side, if you sold something less than what you paid for it, it’s a loss.
Income Generation, Dividends, or Interest
This is when you receive an income just by owning an income-generating asset. Examples of this type of investments include the income you receive from a business you own or a rental income from your real estate property. This also includes dividends from a stock or an interest from a bond.
Dividend refers to the income you receive just by owning “stocks” of a company. You can think of stocks as pieces of ownership of a company that individuals or organizations can purchase and sell. If you own a stock of a company, you’re considered as a “shareholder” or a partial-owner of a company. Companies usually compensate shareholders through dividends. The amount of income you receive from a stock’s dividend depends on how much share you own from a company. For example, if you own 100 shares of Company A’s stocks and they paid ₱20 per share, that means you’ll earn ₱2,000 worth of dividends (100 shares x ₱20). You’ll continually receive dividends for as long as you own the stocks of a certain company. Note that some companies don’t pay dividends, so investors in these companies solely rely on capital gains.
Now moving on to bonds and interest. An interest refers to the income you make by owning “bonds”. A bond is a contract between a lessor and a lessee. If you own a bond, that means you’re entitled to receive the principal repayment plus the interest paid by the lessee. There are many forms of bonds you can invest in, some of which include the corporate bonds where you lend money to corporations, and government bonds where you lend money to the government. A government bond (also called Treasury Bills or T-Bills) is considered as a safe and secure form of investment, since the government is less likely to default on their payments. Now let’s say you invested in a government bond for ₱100,000 with an annual interest of 4% and a maturity period of 10 years. What this means is that by owning this government bond, you can expect to receive ₱4,000 (4% of ₱100,000) per year for the next 10 years, and receive the ₱100,000 principal after 10 years. Note that the structure of terms and the level of risk depend on what bond you are investing in, so it’s important to do your own due diligence.
Factors to Consider When Investing
The amount of money you invest: The more money you invest, the more potential returns you can earn.
The rate of return on your investments: The higher the rate of return, the faster your money grows. For example, an investment with a return of 20% will grow your money faster than an investment with just 4% return.
The time period of your investments: The longer you hold your investments, the more compounding effects you can enjoy.
The fees and taxes on your investments: The lower the fees and taxes, the more money you can keep.
Where to Invest Your Money?
There are many types of investments that you can choose from, depending on your risk tolerance and investment objectives. Generally, investments can be classified into three categories based on their risk level:
These are investments that have a low chance of losing value or defaulting on payments. They usually offer low but steady returns and are suitable for conservative investors or those who need their money in the short term. Some examples of low-risk investments are:
Savings accounts: These are accounts that pay interest on your deposits and allow you to withdraw your money any time. They are insured by the government up to a certain limit and are very safe and liquid. Savings accounts are ideal if your risk tolerance is very low and you don’t want to risk losing any of your money, but are still looking for ways to grow it. Since a savings account is a very liquid investment (you can withdraw your money anytime), it is ideal for storing your emergency fund or your fund for a short-term goal (like traveling to another country).
Treasury securities: These are debt instruments issued by the government to finance its operations and debt obligations. They pay a fixed interest rate and have varying maturities, from a few weeks to 30 years. They are backed by the full faith and credit of the government and are very safe but have low returns. Like savings accounts, this is ideal for risk-averse investors or for financial goals where you need a safe and secure place to park your money.
These are investments that have a moderate chance of losing value or defaulting on payments. They usually offer higher returns than low-risk investments but also involve more volatility and uncertainty. They are suitable for moderate investors or those who have a longer time horizon and can tolerate some fluctuations in their portfolio value. Some examples of medium risk investments are:
Corporate bonds: These are debt instruments issued by corporations to raise funds for their business activities. They pay a fixed or variable interest rate and have varying maturities and credit ratings. They are less safe than treasury securities but offer higher returns. Corporate bonds are considered as a medium risk investment vehicle because companies can go bankrupt, although in the event of bankruptcy, the debts are prioritized to be paid first from selling their assets. This investment vehicle is fit for investors with a little more appetite for risk who want to grow their investments a little more than the low-risk ones. This is also ideal for medium-term financial goals like saving for a down payment (like in a house) or saving up a starting capital for starting a business.
Mutual funds: These are pooled funds that invest in a diversified portfolio of securities, such as stocks, bonds, or other assets. Professional fund managers who charge fees for their services manage them. They offer diversification and convenience but also involve risks such as market risk, manager risk, or fund expenses. This type of investment is ideal for investors who want to have a diversified investment portfolio but don’t have the time or expertise to find and analyze different investment vehicles. By paying a small amount of fee, investors can leverage the time and knowledge of a fund manager, although they don’t have much control as to where the fund manager invests. And like in corporate bonds, this type of investment is also ideal for parking your money for a medium-term financial goal.
These are investments that have a high chance of losing value or defaulting on payments. They usually offer very high returns but also involve very high volatility and uncertainty. They are suitable for aggressive investors or those who have a very long time horizon and can afford to take high risks with their money. Some examples of high-risk investments are:
Stocks: These are shares of ownership in a company that entitle you to a portion of its profits and assets. They trade on an exchange (like the Philippine Stock Exchange or PSE) and have varying prices and dividends depending on the company's performance and market conditions. They offer high growth potential but also involve high risks such as business risk, market risk, or price fluctuations. This investment vehicle is ideal for investors willing to take more risk for a higher reward, who also have the time and expertise to analyze each company in a stock market. This is also ideal for funding your long-term financial goals (such as a college fund) since you have a long-time horizon so you’re not much affected by the volatility of the prices, although it still depends on the company’s performance.
Cryptocurrencies: These are digital currencies that use encryption techniques to secure transactions and control their creation and distribution. From an investment point of view, crypto prices are highly volatile. What might trade for ₱1,000 today might be just worth ₱50 by next week. Due to its high volatility nature, cryptos are ideal for investors with a very high risk appetite.
Investing is a powerful way to grow your wealth and achieve your financial goals over time. However, investing also involves risks that you need to understand and manage according to your personal situation and preferences. You should always do your research before investing in any type of asset and diversify your portfolio across different asset classes and risk levels to reduce your overall risk exposure. It’s also a good thing to consult a professional financial advisor for guidance and advice regarding your personal finance and investment concerns.