Investment Journal

In my last post about the power of compound interest, I said that learning its power will make us realize that we should start saving now, or if not now, at least as soon as we can. I also gave you an example about the difference between simple and compound interest. And that, compound interest can give you higher return by reinvesting your earned interest to earn more interest. In this post, I would like to give you another two short examples that will show you why we should start saving now.

If you are serious about saving or investing your money, you should understand compound interest. But if you think you're not yet ready to enter the investment world, and you think that you still have to wait 3 or 5 more years before you start saving money, then I think you're the one who really needs to understand the power of compound interest. Learning its importance and power may make you realize that you should start saving money NOW.

Q: What is compound interest?

A: It is simply an interest earning interest. Sounds simple? Yeah, but it is really powerful.

Q: How?

A: Let me give you an example:

Let Say you and your friend each has P100,000 to invest. Your friend chooses an account yielding simple interest at 5 percent. This means that each year his money is increased by P5,000, 5 percent of the principal investment P100,000. After year one, he has P105,000; after year two, P110,000; after year three, P115,000; and so on.

You, on the other hand, put your P100,000 in an account that returns 5 percent compound interest. This means that you get interest not only on your original P100,000, but on the interest that is added to it as well. At the end of year one, you will also have P105,000. In year two, you earn another 5 percent, but now it's 5 percent of P105,000, not of P100,000. So instead of getting P5,000 you get P5,250, bringing your total investment to P110,250. The third year, you get P5,513 The fourth year you get P5,788. Why does the interest keep on growing? Because you reinvest the interest you get every year, and that what makes your money grow faster. After 20 years, your friend's total investment will be P200,000 and your total investment will be P265,329.77. In this example, we only use 5% interest rate. What if we use 10% instead of 5% interest rate? After 20 years, your friend's total investment will be P300,000 and your total will be P672,749.99!

The basic guideline in investing is the country's inflation rate. All your savings for the long term, time deposits and other investments must produce rates that are higher than inflation. Your earnings rate should be 2 to 4 percent above inflation rate. So, if the inflation rate is 6%, your earnings rate should be 8 to 10%. Otherwise, you will lose a great deal of money especially if you invest for the long term. The longer the term, the higher the risk that at some point inflation will rise dramatically and reduce the value of your money. The money you save will not be enough to buy the same goods you are able to buy today. For example, you put 1,000,000 pesos in time deposit for one year and the bank's interest rate is 3% net per annum. If after one year inflation rate shoots up to 5%, your money will still lose 2% in value. Imagine how much you will lose if you will keep on doing this for 10 years.

I will be preparing an easy to understand examples for stocks, bonds, mutual funds and options. I will post it immediately when i finish it. For now, let me remind you again why we should invest.

So why should we invest?

If you don't want to work for money all your life then you should learn how to invest. Investing makes your hard-earned money work for you. Putting all of your money in the bank is not the only option. There are different types of investment instruments that you can use to maximize the earning potential of your money. If you're only planning to save for the short-term and think you're going to need the money in six months or less and you're saving it for emerngency fund then the bank might be suitable for you. But if you're planning to save for the long term, saving in a bank might not be a good idea. Why? Because bank's annual return rate(3%) is not enough to beat the inflation. In mutual fund, its possible to earn 10-30% annual return on your investment. Stocks, currency trading, futures and options can give you more than 30% or even 100-300%. But of course, there will be some risk included, but did anybody ever become successful in the world of investing without taking any risk?


For some people, investing is risky but other people think investing is risky only if you don't know what you're doing. Many also believe that to get higher return means you have to take on more risk. As the best-selling author Robert Kiyosaki said: "There are three types of investors in the world. They are : People who do not invest at all, people who invest not to lose and the people who invest to win." He said that those people who do not invest at all expect their family, the company they work for or their government to take care of them once their working days are over. People who invest not to lose invest in what they think are safe investments and these people have the saver's mentality when it comes to investing. The third type of investor who invest to win are willing to study more, want more control and invest for higher returns.

Money-market funds resemble savings accounts. For every dollar you put in, you get a dollar back, plus the interest your money earns from the investments the fund makes. Since these funds are usually price-stable, some investors prefer them to stock or bond funds. But the interest the funds pay is low when interest rates are low. In some cases, money-market funds let investors write checks against their accounts. There's usually no charge for check-writing although there may be a per-check minimum.

Like bonds, open-end bond funds produce regular income. Unlike bonds, however, these funds have no maturity date and no guaranteed repayment of the amount invested. On the plus side though, the earnings can be reinvested in the fund to increase the principal. And buyers can invest a much smaller amount of money than they would need to buy a bond on their own and get a diversified portfolio to boot. For example, some bonds may require an investment of $100,000 and make additional purchases for even smaller amounts.

Bond funds come in many varieties, with different investment goals and strategies. There are investment-grade corporate-bond funds and riskier funds, often sold under the promising label of high-yield funds.

Stock funds invest primarily in stocks. But stock fund portfolios vary, depending on the fund's investment objectives. For example, some stock funds invest in well-established companies that pay regular dividends. Others invest in young, high-technology firms or companies that have been operating below expectation for several years.

Like individual investors, funds may buy blue-chip stocks for income and safety, growth stocks for future gains, value stocks for stability and growth, and cyclical stocks to take advantage of economic booms. For investors, the major difference in buying a fund rther than individual stocks is the diversity they can achieve for the same amount of money.

Mutual funds fall into three types or categories: they are the stock or equity funds, Bond funds and money-market funds.

A typical stock fund may own shares in 100 or more companies that provide a range of different products and services. A government-bond fund may own issues of dif different terms, paying varied rates. And a money-market fund stays liquid or cash rich, by owning very short-term debt.

Mutual funds are created by investments companies, brokerage houses, banks and other financial institutions. Here in the Philippines, banks called it UITF or unit-investment trust fund or formerly known as common trust fund. A company frequently offers a range of funds. In some cases, companies offer funds in more than one market or establish legal bases in more than one country to increase their market share. Many U.S banks, for example, sell funds in Asia in addition to those they sell in the U.S. Because certain countries have more liberal tax policies than others, investment companies often prefer to use them as a legal base. Funds based in tax havens are often called offshore funds.

If you want to earn higher than banks and bonds could offer but you're not yet ready to take a plunge in the stock market, you might want to try investing in MUTUAL FUNDS. Most investment professionals agree that its smarter to own a variety of stocks and bonds than to gamble on the success of a few. But diversifying can be tough because buying a portfolio of individual stocks and bonds may be expensive. And knowing what to buy and when can be a full-time job.

Mutual funds offer one solution. When investors put money into a fund, it's pooled with money from other investors to create greater buying power than they would have investing individually.

Since a fund can own hundreds of different securities, its success isn't dependent on how one or two holdings do. And the fund managers keep constant tabs on the markets, adjusting the portfolio to reflect changing conditions.

One of the disadvantages of a mutual fund is the charges. You have to pay management fee for the the fund managers whether or not they do a good job. They generally charge around 3% as entry fee and around 2% for management fee and if you don't hold to your shares for at least one year, there is an exit fee of around 2%.

The corporations and governments that issue bond all want to raise money from investors, though not for the same reasons. Corporations often need large amounts of cash to finance growth and development. The issuers believe that the borrowed money will help build the business and help increase their earnings, and the increased earnings will be available to repay the loans.

Governments aren't profit-making enterprise, so bonds are the primary way they can raise money to fund capital projects such as roads and other infrastractures. Bonds also provide the money to keep everyday government operations running when other revenues aren't sufficient to cover the cost. When governments have an operating deficit, they may need to borrow increasing amounts from investors.

The life or term of any bond is fixed at the time of issue. It can range from short-term intermediate-term to long term. Government bonds usually come in the form of treasury bills(one year or less), treasury notes(2 to 10 years) and treasury bonds(10 to 30 years). Generally speaking, the longer the term, the higher the interest rate that's offered to make up for the additional risk of tying up money for so long a time. The relationship between the interest rates paid on short-term and long-term bonds is called the yield curve.

When inflation is up, interest rates go up and when inflation is low, so are interest rates. It's the change in interest rates that causes bond prices to move up or down.

If a government issued bonds offering 6% interest, it seems like a good deal; so you buy some bonds at the par value price of $2000. Two years later, interest rates are up. If new bonds costing $2000 are paying 8% interest, no buyer will pay you $2000 for a bond paying 6%. If you want to sell your bond you'll have to offer it at a discount, or less than you paid. If you must sell, you might have to settle for a price that wipes out most of the interest you've earned.

But if new bonds selling for $2000 offer only a 3% interest rate, you'll be able to sell your 6% bonds for more than you pay. Since buyers will agree to pay more to get a higher interest rate.

The value of a bond is determined by the interest rate it pays and by what's happening in the economy. A bond's interest rate never changes eventhough other interest rate do. If the bond is paying more interest than is available elsewhere, investors will be willing to pay more to own it. If the bond is paying less, investors won't buy it unless you sell it at a bargain price or lower than the value of the bond.

Interest rates and bonds prices fluctuate like two sides of a seesaw. When interest rates drop, the value of existing bonds usually goes up. When rates climb, the value of existing bonds usually falls.

Several factors including yield and return affect whether or not a bond turns out to be a good investment.

If the bond investor buys at par, and holds the bond to maturity, inflation, or the shrinking value of the currency, is the worst enemy. The longer the maturity of the bond, the greater the risk that at some point inflation will rise dramatically and reduce the value of the money that the investor is repaid.

If the bond pays more than the rate of inflation, the investor comes out ahead. For example, if a bond is paying 8% and the annual rate of inflation is 3%, the bond produces real earnings of 5%. But if inflation shoots up to 10%, the interest earnings won't buy what they once did. And in either case, the principal invested in the bond also shrinks in value.

Many conservative investors use bonds to provide a fixed income. They buy a bond when it's issued and hold it for one, three or ten years, expecting to recieve regular, fixed interest payments until the bond matures. When interest rates fluctuate, as they do in certain economic conditions, some investors try to make money by trading bonds rather than holding them. Bonds that are issued when interest rates are high become increasingly valuable when interest rates fall. That's because investors are willing to pay more than par value for a bond with a 10% interest rate if the current rate is 7%.

In this way, an increase in the price of a bond, or capital appreciation, often produces more profits for bond sellers than holding the bonds to maturity.

But there is also risk in bond trading. If interest rate go up, buyers may lose money because the bonds they hold don't pay as well as the newer ones being issued. And they won't be able to get back the full amount that they've paid for the bond if they sell.

Bonds are loans that investors make. The borrowers get the cash they need while the lenders earn interest. Bonds are issued by large corporations and governments to raise funds for their projects. Bonds appeal to many investors because they promise to pay a set amount of interest on a regular basis. That's why they are called Fixed-Income securities.

Another good thing about Bonds is that the issuer promises to repay the loan in full and on time. So bonds seem less risky than investments that depend on the ups and downs of a stock market. If you are saving and don't need to earn money right away, this investment instrument will give you a good return without too much risk. Your money can earn interest higher than the rates paid by banks.

A bond has also a fixed maturity date when the load expires and must be paid back in full, at par value, or the amount it cost when it was issued. The interest a bond pays is also set when the bond is issued. Government bonds usually come in the form of treasury bills and treasury bonds(5, 10 or 30 years term). The longer the term, the higher the interest rate. Government bonds are safer than bonds issued by large corporations because only the government can print money to pay off government securities and large corporations don't have any guarantees that they can pay off their loans in case they go out of business.

If you don't want to work for money all your life then you should learn how to invest. Investing makes your hard-earned money work for you. Putting all of your money in the bank is not the only option. There are different types of investment instruments that you can use to maximize the earning potential of your money. If you're only planning to save for the short-term and think you're going to need the money in six months or less and you're saving it for emerngency fund then the bank might be suitable for you. But if you're planning to save for the long term, saving in a bank might not be a good idea. Why? Because bank's annual return rate(3%) is not enough to beat the inflation. In mutual fund, its possible to earn 10-30% annual return on your investment. Stocks, currency trading, futures and options can give you more than 30% or even 100-300%. But of course, there will be some risk included, but did anybody ever become successful in the world of investing without taking any risk?

For some people, investing is risky but other people think investing is risky only if you don't know what you're doing. Many also believe that to get higher return means you have to take on more risk. As the best-selling author Robert Kiyosaki said: "There are three types of investors in the world. They are : People who do not invest at all, people who invest not to lose and the people who invest to win." He said that those people who do not invest at all expect their family, the company they work for or their government to take care of them once their working days are over. People who invest not to lose invest in what they think are safe investments and these people have the saver's mentality when it comes to investing. The third type of investor who invest to win are willing to study more, want more control and invest for higher returns.

There are a lot of people who want to learn how to invest, who want to understand stocks, bonds, currency trading, futures and options, real estate and mutual funds. I made this blog to give you the basic of these investment instruments and how they work.