Part III: Things to do before investing

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One of my many mistakes when I was starting was to disregard some of the important things about investing, such as tying it with a personal goal, knowings its and returns.

In this article, I am going to write about what makes your investment meaningful, what are the uncertainties that you face and the potential earnings that you get.

Financial goal

Few years ago, I started investing because it was exciting, fun and there was a possibility to earn an income. And that’s just not okay. Because I didn’t have any personal reason aside from it being new to me, there was nothing that stopped me from pulling all my investments at a minute’s notice.

You need to have a reason for investing, and that is what a financial goal is for. It ties your investment to something that means a lot to you at a specific period in the future. It can be anything from buying a house, preparing for your retirement or saving for your kid’s college education.

From your goal, you can work out the following:

  • The size of savings that you need. You can at least try to estimate the amount of money that you need to achieve your goal.
  • Time left for you to save and invest. This is a crucial factor as it provides you how much time you have to accumulate the needed amount.
  • Changes in your lifestyle that you need to make. You would then have to include your savings as part of your regular budget. And that would entail some sort of giving up on little purchases that you would have done if you didn’t save.

Potential for returns

Then, you can figure out the the financial product that suits you. It will be clearer just exactly what kind of investment that closely meet your goal.

For example, let’s say that you would need P100,000 in ten years, and you decide that you are going to save P5,000 ever year for the next twenty years. But if you invest, you can actually complete your goal in less time.

Let’s assume that you have three investment options: one that earns 5%, 8% and 10% compounded annually. Below is a table showing how much your savings (the actual amount of money that you save), and the returns of each of the three options.

Years Total Savings 5% 8% 10%
1 5,000 5,250 5,400 5,500
2 10,000 10,763 11,232 11,550
3 15,000 16,551 17,531 18,205
4 20,000 22,628 24,333 25,526
5 25,000 29,010 31,680 33,578
6 30,000 35,710 39,614 42,436
7 35,000 42,746 48,183 52,179
8 40,000 50,133 57,438 62,897
9 45,000 57,889 67,433 74,687
10 50,000 66,034 78,227 87,656
11 55,000 74,586 89,886 101,921
12 60,000 83,565 102,476
13 65,000 92,993
14 70,000 102,893

What this table tells you with investing is, you could possibly have a shorter time achieving what you want in life. At 5%, you can achieve it in 14 years, at 8% in 12 years and at 10% in 11 years.

But what’s more striking is the fact that you also don’t have to sacrifice as much! If you were to just put your money in a piggy bank, it’s going to take you twenty years of your life before you can have a P100,000. And what’s more, you actually have to save P100,000!

By investing, you will only have to save P70,000 at 5%, save P60,000 at 8% and P55,000 at 10%.

Risks

Of course you would pick the option that offers the highest interest earnings and has shortest timeline, which is the 10% investment vehicle. The reality is, the higher the potential for returns the higher is the risk that you’re going to take.

There are two distinct risks that you run into:

  • failing to meet expected returns. That is, your investment vehicle might not be able to gain the expected annual interest.
  • experiencing actual capital loss. Your investment vehicle might be exposed to assets that are volatile, and that might lessen the amount of money that you saved. This is typical in times of slowdown in the economy.

If you decide to open a managed fund, like a mutual fund or an investment-linked policy, you will be generally offered three types of investments. Each one of them has different risk and return tradeoff:

  • Equities fund, invested primarily in stocks, offers high returns but also with high risks.
  • Balanced fund, invested about half in stocks and half in bonds, offers moderate returns but also with moderate risks.
  • Bond fund, invested primarily in bonds, offers low returns but also with low risks.

The need for financial foundation

Precisely because you open yourself to risks that there is a need for a solid financial foundation. What else do you need to do before actually investing? Should you just begin investing without taking into considerations other things that might be important such as setting aside money for emergency situations?

These are the questions I’m going to answer in the next part. So click Continue to know more.