Investment for Beginners
August 6, 2020
Investing is a way to save money while you are busy with life and make that money work for you so that you can fully reap the rewards of your work in the future. And we know that it can seem complicated when you don't have a broad overview of the different options for investing your money and how each one works, so having a guide that explains the steps to follow and their variants turns out to be quite useful in practice. So that will be the goal to teach!
Criteria before start investing
Before knowing how each market works you should take into account your needs and the criteria with which you should qualify them. As well as the different points of view from which you can evaluate an investment.
AMOUNT: depending on the amount of money you are willing to invest, you can use different types of instruments. Decide what amount you want and invest, without forgetting that you should try to maintain a balance in your budget.
TERM: is the commitment of time in which your resources will remain invested without being able to dispose of them. It is also considered as the time that must pass for you to get the return you want. Consider:
- The longer the term, the greater the return.
- The shorter the term, the lower the return.
LIQUIDITY: is the ability to convert a financial instrument into cash, meaning an instrument is easier to liquidate the easier it is to sell. Liquidity is usually associated with yield. The simpler it is to liquidate it, the lower its yield tends to be. Otherwise, the return it will offer is likely to be higher.
RISK: it refers to the probability that you will not make a profit as a final result or even lose your investment. However, risk is a variable that behaves proportionally to return. Consider:
- A high-risk investment is one that is likely to give you a greater return or reward, but also to have a greater loss.
- A lower risk investment will give you a lower return, but you will have greater certainty of the gain and you will even be able to know it in advance.
The decision of what type of investment you can make will depend on your profile as an investor and how much you are willing to risk.
PERFORMANCE: this fifth variable represents the ultimate goal, making a profit. It is related to the four previous variables. The return is the fruit you will obtain when you invest. It can take different forms:
- Interest: percentage that represents the return generated by an interest rate.
- Capital Gains: is the increase in the value of the instrument.
- Dividends: it depends on the company's profits reflected in the value of the shares.
A guide to each market
Remember that an investment is based on any activity where a future benefit from an asset is postponed and expected. There are a variety of markets in which money can be invested. The main markets are stocks, bonds, FOREX and private equity (currencies). In addition, within each of these types of markets, there may be even more specialized markets.
PRIVATE EQUITY (Risk: High and Low, depending on the category)
Private equity is the ownership of shares or an interest in a company that, unlike other existing investments, is not publicly traded or listed. Most of the private equity industry is made up of large institutional investors, such as pension funds, and large private equity firms financed by a group of reputable investors. Since the basis of private equity investment is a large direct investment, it should be said that it is a type of investment exclusively for experienced investors or high-level funds. Some funds have a minimum investment requirement of $250,000, while others may require millions of dollars.
The types of private equity can be classified into two sections:
- Venture Capital: Venture capital funds are common equity funds that typically invest in small, early stage and emerging companies that are expected to have high growth potential but have limited access to other forms of capital. From the point of view of small start-ups with ambitious value propositions and innovations, venture capital funds are an essential source of capital, as they do not have access to large amounts of debt. From an investor's point of view, although venture capital funds involve risks when investing in unconfirmed emerging companies, they can generate extraordinary returns.
- Buyout: A leveraged buyout fund combines investment funds with borrowed money to acquire companies and improve their profitability. This means that private equity firms buy companies using a little bit of their own money and a lot of borrowed money. Unlike venture capital funds, buyout funds invest in more mature businesses, usually by taking a majority stake. In exchange for lending money to the company to finance a buyout transaction, the firm guarantees the debt using hard assets and promises of cash flow/working capital of the company, which allows lenders to have a higher seniority in case of bankruptcy liquidation.
STOCKS (Risk: High)
A stock is a type of investment that represents an ownership share in a company. Investors buy stocks that they think will go up in value over time.
Companies typically begin to issue shares in their stock through a process called an initial public offering, or IPO. Once a company’s stock is on the market, it can be bought and sold among investors. If you decide to buy a stock, you’ll often buy it not from the company itself, but from another investor who wants to sell the stock. Likewise, if you want to sell a stock, you’ll sell to another investor who wants to buy.
Steps for investing in stocks:
1. Learn about the market: Before you can move on, make sure you have a solid understanding of the concepts involved in stock valuation. The better you value your investments, the better your portfolio will be.
2. Stock valuation: Now that you know the basics of stock trading, you can choose a stock to invest in. Keep in mind that it's easier to choose profitable stocks if you choose to invest in companies and industries you know. To find out if the stocks are worth their current market value, you need to go deeper and analyse their economic position, how much its assets are worth, how much the company has been earning, how much it is spending and how much it is paying its shareholders in dividends. Stock valuation uses the following metrics for fundamental analysis:
- Earnings per Share (EPS)
- Price-Earnings Ratio (P/E)
- Dividend Yield
- Price-Book Ratio (P/B)
3. Get to know the brokers: There are some types of commission-free investments that can be processed directly to the seller. If you decide to buy securities that do not need a broker, all you need to do is create an online account to manage and fund your investment. But if you want to buy stocks that require a broker, such as individual stocks or mutual funds, take advantage of the brokerage service that aligns with your specific financial capacity. In addition, brokers can also provide you with investment advice.
4. Lets buy: Now that you have a broker, all you need to do is fund your investment account, then you're good to go. Check the stock price and then indicate the number of shares you want to buy. After checking the total price of the trade, instruct your broker to proceed with the trade by placing the appropriate order type. After setting the order type, press send. Your decision to buy has been officially made and once the trade has been accomplished, your broker will then charge you commission and other applicable fees.
BONDS (Risk: Low)
A bond is a fixed income instrument that represents a loan made by an investor to a borrower. But that's all a bond is — a loan. When you buy a bond, you're lending money to the organization that issues it. The company, in return, promises to pay interest payments to you for the length of the loan. How much and how often you get paid interest depends on the terms of the bond. The borrower issues a bond that includes the terms of the loan, interest payments that will be made, and the time at which the loaned funds (bond principal) must be paid back (maturity date). The interest payment (the coupon) is part of the return that bondholders earn for loaning their funds to the issuer.
Steps for investing in bonds
1. Deciding what kind of bonds to buy: Not all bonds are created equally. In fact, there are several types of bonds you might choose to buy:
- Corporate bonds: are those issued by companies. The interest you receive on corporate bonds is subject to both state and federal taxes.
- Municipal bonds: are those issued by cities, states and other localities to finance public projects and increase public services. The interest you receive on municipal bonds is always exempt from federal taxes.
- Treasury Bonds: These are issued by the U.S. government. The interest you receive on T-bonds is taxable at the federal level, but is exempt from state and local taxes.
Although there is generally no such thing as a risk-free investment, treasury bonds are considered virtually risk-free. Municipal bonds, while not risk-free, are considerably less prone to default than corporate bonds. On the other hand, corporate bonds tend to offer the most generous yields.
2. Plan your investment: You are not required to hold your bonds to maturity, however if the value of your bonds falls after you buy them, you may have no choice but to hold them for the long term to prevent your principal investment from being affected. Because bonds have different terms, setting some investment goals can help you determine how long you can hold onto your money.
If you are going to load your portfolio with bonds, you might consider a stepwise approach, buying different bonds with staggered maturity dates. This not only ensures a reliable stream of interest income, but also provides you with more built-in liquidity, since you will have different bonds maturing at different times. By having your bonds mature at frequent intervals, you are giving yourself a chance to get out of the bond market and put your money elsewhere as better investment opportunities arise.
3. Set up a brokerage account: Investors can purchase bonds through a brokerage firm which is in communication with governments and companies that want to issue debt. They also have access to the markets where bonds trade in the secondary market.
FOREX (Risk: High)
Forex can be explained as a network of buyers and sellers, who transfer currency between each other at an agreed price. It is the means by which individuals, companies and central banks convert one currency into another. It is this volatility that can make forex so attractive to traders: bringing about a greater chance of high profits, while also increasing the risk. Unlike shares, forex trading does not take place on exchanges but directly between two parties, in an over-the-counter (OTC) market.
Steps for investing in forex
1. Understand basic forex terminology: As with any other market, it must be understood what you will be dealing with and for this you should do a previous search of the terms and concepts used in this market to have a better understanding of its different investment options.
2. Decide what currency you want to buy and sell: Investors should carefully consider risk-management techniques to help mitigate these risks and improve their long-term returns. For this the most convenient is to make predictions about the economy, considering the commercial position of a country, the politics and its economic reports. For example:
- If you believe that the U.S. economy will continue to weaken, which is bad for the dollar, then you will probably want to sell dollars in exchange for a currency from a country where the economy is strong. If a country has many goods that are in demand, then the country will probably export many goods to make money. This trade advantage will boost the country's economy, thus increasing the value of its currency.
- If a country has elections, then the country's currency will appreciate if the winner of the election has a fiscally responsible agenda. Also, if a country's government loosens regulations for economic growth, the currency is likely to increase in value.
- Reports on a country's GDP, for example, or reports on other economic factors such as employment and inflation will have an effect on the value of the country's currency.
3. Start the trading with a brokerage: Many online brokers offer forex trading, so select among the available options. There are many different currency platforms to facilitate online trading. Some brokers also have proprietary trading platforms that you can download from their websites or use online. Either way, obtaining and using these platforms is usually quite simple using the instructions that your chosen broker will provide.
Before performing a live trade, you will probably want to take some time to learn how to enter and exit the trade correctly using your online trading platform with a demo account before performing a real trade. This can help you avoid costly mistakes. Once you feel confident in your ability to use the platform, you will be ready to enter your first trade.
It could be considered as general knowledge what is the concept of investing, but many times we do not know the different options that exist and even less how to participate in them. The knowledge of this information is considered as a basic backup and very useful to start a more in-depth investigation of the option that is of your personal interest. Just take it slow, get informed and you'll be on the other side.
Credits: Sara Escamilla Enríquez, Luis Miguel Almanza Rueda, Itzel Pamela Becerril Tovar, Rodrigo Alejandro Ibarra Vizcarra, Marcos Abraham Rascón Corona, Ilian Murillo Palma, Gabriel García Nevárez, Priscila Elizabeth Terrazas Rico, Ivan Elias Castro Cordero.