Whether we like it or not, when we become adults, we have to start thinking about our personal finances and planning our future. For those who have not been taught about finances (I know pretty much none of us learnt this in school), planning finances could be a daunting task. The words ‘investment’ and ‘insurance’ often fill people with dread; is it a scam? Why should I spend my money on that? Do I need it?
The long and short of it is, both are important and you need both. But is one more important than the other? Let’s look at both and see for ourselves.
There are lots of kinds of insurance products but they all cover one thing- loss. The whole point of insurance is that it covers us if something goes wrong. This may be a hospitalisation, a disability, an illness, or some other kind of liability that would set us back financially. It is meant for protection; protecting us from the adverse effects of not being able to work or financial hardships. Many people think that planning for these things, such as death or disability, is a morbid topic and a worst-case scenario. But good health is never guaranteed, and it’s always best to get these things sorted before it’s too late. Insurance products also become more expensive as you get older, so it’s best to start early, so that these payments don’t interfere with any of your future life stages like purchasing a house or sending your kids to school.
Investing is all about growing money for our future- we can either plan for a passive income stream, so that we don’t have to rely on work so much. Or, we can plan for capital gains, so that we have a nice chunk of money when we want it. The idea of making money with not necessarily putting too much effort in (check out my articles about passive investing), is an attractive one. And, if we make all this money, why do we even need insurance?
Unfortunately, the truth of the matter is, it is unwise to have one without the other; investment increases our upsides, but insurance protects our downside. If you invest without being insured, you run the risk of losing it all should you fall sick or become hospitalised (also, can I just say, it’s very naïve to think you will stay healthy forever), especially if your investments are not enough to pay for your bills. If you just insure yourself without investing, you are selling yourself short, only planning for the bad things that can happen, and not planning for the good times ahead. It also means that you may have to constantly work and never be able to retire. Neither insurance nor investments will work on their own; you need to plan and review both in order to be financially successful.
A very important thing to take note of is that investments take a long time to accumulate, especially if you cannot set aside a lot of money to invest. Insurance policies cover you pretty much as soon as you get them. So, it’s always important to sort your insurance out first; once you are protected you can focus on growing your money.
But do remember that investing and insurance is never fixed and one-size-fits all. You need to constantly review your finances in order to keep up with your changing needs!
Money saved is money earned…right? Not necessarily in the long run. Rising inflation rates can mean that you’re actually losing money by leaving it in your bank account.
If we take my DBS account as an example; the interest rate is a lousy 0.05%. The average rate of inflation in Singapore is projected to increase to 2%. In theory, if I leave $100,000 in my bank account for 5 years, I will have $100,250 after interest. However, this amount of money will have lost buying power. In theory, my money in 5 years will actually be worth $90,622; I will have lost $9,378 just by leaving my money alone! (It has a negative rate of -1.95% when inflation is taken into account.)
While inflation shows an upward trend in the economy, it can be a massive hindrance to our bank accounts! So what do we do? There are a couple of ways to take action today! The first one is to find a savings account that offers you a higher interest rate. Some offer 2%-3%.
The second and most effective way is to put your money in instruments that will get you a much higher rate of return. This is why I feel that investing is key; even if you find something that yields a conservative 4%, your $100,000 in 5 years would be $121,665.
I will be writing about in a future article the benefits of different investment instruments.
Hindsight is bitter sweet; it’s very easy to sit back and relax and leave your money alone…but you will regret it in the long run.
Do you find that there are just too many financial terms to remember, putting you off even considering investing? Well, there is a lot, and at first glance it is definitely overwhelming. So, I have complied a list, a mini dictionary, if you will, of all thing’s money- from hedge funds to dollar cost averaging. At the end, a lot of these term won’t seem so formidable anymore, allowing you to start investing with a lot more confidence.
The first word that everyone thinks of when they hear the term ‘investment’, is stocks. Hence, why it is first in this list. But what even are stocks? And how do they work? A stock, also known as equity, represents the ownership of a part of a company. Imagine a company is like a big pie, and you want a piece of the pie. You can buy a slice, known as a share, and essentially you own a small part of that business’ assets and earnings. (Do note, however, this does not mean you own part of the company’s furniture, building or whatsoever you choose).
Shareholders (people that own the stock) can vote in shareholders’ meetings, sell said shares to others and receive dividends- more on that later.
Stocks are bought and sold on stock exchanges, although some can be sold privately. Historically, stocks out-perform other types of investments, which we will delve into further later.
But why do companies sell stocks? Don’t they want the whole pie to themselves? Simply put, companies sell stocks to raise funds so that their business can operate.
You may have heard of a bond before when the topic of investment comes up. A bond is a fixed income instrument that works similar to an I.O.U. It represents a loan made by an investor to a borrower- just like an I.O.U. Its details include the loan due date and includes the interest and terms for payment.
They are normally used by corporations or government entities to pay for projects. Imagine you are a contractor, wanting to build a block of flats. You need equipment, materials, not to mention staff to carry out the job. All this costs money, sometimes more than a bank is willing to loan. So, you can instead ask many investors to lend the money to you. This is a bond.
Like stocks, bonds can be bought and sold, publicly or privately. They pay out lower than stocks, but are a safer option; if you hold your bond until maturity (the date it was supposed to end), you will get all your principal back. Principal is the amount you paid in the first place.
All these different ways of investing can seem a bit confusing. And doesn’t it require a lot of time, sitting and watching how my stocks are doing? And how do I know which stocks to buy? Or even if I should just stick to stocks! Well, that’s where mutual funds come in. A mutual fund is a pool of money that can be invested in different investment types, such as stocks, bonds and money market instruments. They are managed by professional money managers, who will decide how much money goes into what, and will shuffle funds if necessary. This is a great investment vehicle for those who do not want to invest hands-on, or do not have the expertise to do so. Money managers will try to make profit based on the investment objective. However, remember that these managers will charge a fee for doing all this for you.
Hedge funds are very similar to mutual funds; they both are actively managed and both use a pool of funds to invest. However, they face less regulation than mutual funds, and sometimes use non-traditional investment strategies. They are more expensive than other funds, and are normally specifically for high net-worth investors.
The last type of fund I am going to talk about is index funds. These are a portfolio of stocks that are ideal for saving for retirement. They have cheaper fees and expenses than actively managed funds.
The term ‘indexing’ itself means passive fund management; instead of a fund manager picking and choosing investments, or deciding when to buy and sell, the fund manager will build a portfolio (a range of investments), which mirrors a particular index. The idea is that mirroring the stock market, the fund will match the performance. Nearly every financial market in existence has an index and index funds, the most popular index funds track S&P 500.
Overall, index funds are great for diversification (coming up) and offer strong long-term returns. But, beware, they are vulnerable to market swings and crashes and lack flexibility.
This may be a common phrase that you have heard. The term ‘diversification’ is the opposite to ‘putting all your eggs in one basket’. If you decide to invest all your money into one stock, say from Company X, and the stock crashes, you have risked it all and lost all your money. However, if you invest in several different stocks, in Company X, Company Y and Company Z, and Company X’s stocks crashed, at least you would still have your shares from the other companies. What’s even better than this is if you spilt your investments between different types of vehicles, like bonds, stocks, commodities (such as gold). This way you are not solely relying on the stock market doing well.
Diversification is also why mutual funds and index funds are so attractive- your investment is spread out between lots of different asset classes. This massively reduces risk whilst aiming to maximise returns on investments. Diversification also includes geographical location. Investing 100% in a US market is less diverse than investing in US, Asian and European markets.
Managing a diversified portfolio, with assets from different classes and foreign markets can be confusing and time-consuming, which is why mutual funds are available for the layman to purchase.
Some companies will offer dividends; the company will distribute some of its earnings to its shareholders. Dividends are the investors’ reward for putting money into the company. They can either be paid in cash, or in additional stock. They are non-guaranteed, so if the company’s profits slump, so will the dividends (this is unlike coupons, which are a fixed amount).
Dividends are good for those who have short-term investing goals and like to see the benefits of investing instantly.
If you buy a house for $100,000 and sell it for $200,000, you have a capital gain as you have sold your asset for more than you bought it for. This goes for investments too. If you buy stocks and hold onto them, selling them a year later at a higher price, you have a capital gain. Many countries will tax capital gains the same as regular income, but will tax long-term investments less. This encourages long-term investments that benefit the country’s economy. If you wish to benefit from lower tax on your investments, a long-term strategy is better. One thing to note is that there is no capital gains tax in Singapore!
Life is full of risk, and so goes the same for investments. Every investor is tolerable to a certain amount of risk. If you are a high-risk taker, you are willing to take a risk for potentially a high return. If you are quite safe with your investments and invest in say a US treasury bond, then be prepared for lower returns. Generally, in finance, the greater the risk the greater the gain. However, this means that you might risk losing all your investment that you initially put in.
Risk is measured by historical behaviours, although historical behaviour is not indicative of future outcome. Below are some investment types, ranked from low to high risk.
It is generally thought of that low risk = low reward, high risk = high reward. However, there are some ‘hidden gems’ that are low risk with a high reward, these often are too good to be true. Any investment that is high risk, low reward, is generally not worth it.
Dollar Cost Averaging
This concept really is a life-saver for those who do not wish to time the market or sit watching their stocks. The idea is that by putting the same amount of money into investments for the same period (once a month, once a year), you will gain more in the long run than if you tried to time the market.
For example, you spend $20 a month on coffee for 4 months. In January, the value of the coffee drops to $5 each- so you get 4 coffees. In February, coffee is worth $4 each, so you get 5. In March and April, coffees are worth $2.50, meaning you get 8 each month. In total, you purchased 25 coffees for an average price of $3.20. If you would have spent all your money at the same time, you would have only bought 16 coffees, for an average price of $5 per cup.
This method reduces risk and reduces the overall impact of market volatility.
We’ve come to the end of the list, and I’ve saved one of the most important ones until last. Compound interest is essentially interest on interest. Interest is added to the initial amount, and then also on the interest already earned. It makes any sum of money grow faster than simple interest, and is the beauty of investing. Money that you invest over time can compound interest either annually, monthly or any increment of time. There are many financial calculators online you can use, to see how your investment can grow over time. It’s not as simple as just multiplying your initial investment by the rate of return, as it takes into account all the interest gained over a set period of time.
I hope you have found this useful. By now you will know all the basic terms. The investing world is your oyster! Please share this with those you know who are keen to invest. Feel free to comment your questions below!