Investing in investing…

by | Oct 6, 2012

a hot topic to make you financially fit!

My assumption is that if you are reading this article, investments are a mysterious subject, perhaps an area of your life that you ignore due to little interest or lack of knowledge. Altogether, if you had your preference, investing in investing would not be a way you would choose to spend your valuable time and energy. These assumptions are noted to attract those who resonate with the above and therefore will appreciate the forthcoming primer on investing and spare those who are well informed and well versed in an investment practice.  

Investments or the practice of investing is clear. It is always defined as putting money (or other forms of wealth – time, talent) to use for the benefit of something in return, a potential gain sometime in the future. So when we learn about investing and understand the practice, it is essential to begin with the primary motivation. An investment is about receiving something in return at a future date (seconds from now or many years in the future), it is not exclusive of other motivations, but it is the primary impulse, not good or bad, just is.

When one allocates currency, money, to an investment, there are many choices. Assets can be liquid (easily converted into cash) or non-liquid (it takes a longer period to convert the asset to cash). Examples of liquid assets are: stocks, bonds, money market funds, and checking accounts. Examples of non-liquid assets are real estate, some forms of retirement plans, gold, collections (coins, stamps, paintings) and automobiles.

Investments are directly linked to an identified result, such as building an asset base from which to generate income when one is no longer working full time for pay. This is often referred to as retirement; though, with changes in generations, longevity and purpose, our culture is choosing a retirement that looks different from prior generations.  They are choosing to contribute longer by working, volunteering and staying engaged with society. Other identified results for investing may be more finite, such as, funding a car, college education, a vacation, or a home remodel project. The time period of an identified and desired result defines whether a liquid asset or non-liquid asset is more appropriate for your objective.

Always, when building an investment portfolio, the after tax rate of return is considered. Given the changing field of our tax system, the nuances to sustain this posture can be complex. So this statement is offered to your edification and will not be discussed further.

Another very important aspect of investing is risk. Risk is not one “thing” but is experienced in several forms: inflationary risk, volatility risk, currency risk, interest rate risk, capital risk.

Inflationary risk means that over time the cost of a “thing” increases. For example a 25 cent coffee many years ago is now $4.00 at Starbucks.  Volatility risk means that the value (selling price) of an investment fluctuates. The bigger the price swings, the more risky.  Currency risk means that the value of our currency (the US dollar) fluctuates over time in relation to other currencies. For example, the US dollar is worth 18% of what it was worth against the Swiss Franc over the last 40 years.   Interest rate risk means that investment preference is related to the interest rate climate. If interest rates rise, money markets and bonds become more attractive than other investments for the risk reward. Capital risk is the risk of loss of principle. The value of the investment declines due to the value of the underlying security declines. For example, the value of a pearl has declined substantially since the 1800’s. It is known that the current site of Cartier’s in Manhattan was swapped for a pearl necklace in the late 1800s. Not long after this event, Mikomoto discovered how to cultivate pearls and the price of pearls declined significantly. The price of Manhattan real estate continued to rise. These potential dangers need to be faced and understood when investing. Depending upon your objectives, risk tolerance and market indications, one or more of these risks will have a stronger influence on the preferred investment.

Every investment has an attractive aspect (benefit) and a deterring risk (consequence.) That is the art of designing an investment portfolio to meet individual needs and objectives.  Our markets are continually changing, combined with individual circumstances that change; therefore investing strategy is not static and needs to incorporate flexibility. This is why the word diversification is an important concept in investment practices. Diversification means that the portfolio is allocated to many different types of investments that react differently to market fluctuations. Diversification minimizes risk and improves reward over time.

When you begin to practice investing, you will want to keep these factors in your awareness:

  • In addition to other motivations, the motivation to receive a future reward.
  • What is the ultimate objective for this investment to ensure the proper time horizon?
  • Given my individual risk tolerance and my desire for a particular outcome, what types of investments are most suited for me at this time?
  • How much am I willing to lose given my objective?

When you follow these guidelines for your investing, your success as an investor increases with continued practice.