(Part 1 of 2)
A few days ago Charly, a reader, wrote to me about my article on investments and life. He told me that he has read reports and seen the news, but none of them say step by step about how, where or when to invest.
Learning to invest is something that is not difficult, if one has the necessary concepts and clarity of mind. That is what I try to capture in my columns. It is also a process that is refined and adapted over time, because there are different philosophies and strategies.
Before starting it is important to clarify what investing is. Broadly speaking, it is allocating resources to acquire assets with the expectation of generating an income or return (asset appreciation). One does it with different objectives, the most important being the construction of a patrimony (for example, saving for retirement).
Now, acquiring an asset always implies taking risks. All assets, even the most “safe” (government-backed) ones can go down in value, either temporarily or permanently. Let us remember that in this world there are entire countries that are literally bankrupt and cannot pay their debts.
The good news is that risk can always be controlled through diversification, which we discussed in the previous column. So, you don’t have to be afraid of risk: you have to learn to control it.
Broadly speaking, there are actually three ways to invest our money (three big asset classes):
1.- Lending our money to someone else, who pays us interest. For example: a bank promissory note, the Cetes, the Treasury Bonds in the United States, among others. This class of assets is therefore called debt instruments because they represent exactly that: a debt that the issuer owes us. We are lending our money to a government, a bank or a company, who pays us interest from time to time at a rate that can be fixed or variable, and the capital at the end of the term (or at certain intervals). There are different terms: from 28 days to perpetual bonds. When we invest in them there are two main risks: the credit risk (that the issuer cannot meet its obligations) or the market risk (for example, if we have a 30-year bond that pays a fixed rate of 6% but at this moment it is possible to buy bonds with a similar term that pay 8%, our bond will be worth less). The opposite happens if market rates go down (our bond will be more attractive).
2.- Invest in companies or businesses. One can set up one’s own or one can invest in an established and proven business. This is exactly what we do when buying shares of publicly traded companies. Some companies pay dividends (a part of the profits to their partners), many others do not because they reinvest these profits in the business itself. But if a company grows in size and profits, the company is worth more (sooner or later that will be reflected in its share price). There are more risks because companies are in a competitive environment, there are technological innovations, others become obsolete, etc.
3.- Invest in assets that have appreciation potential (or that one can sell more expensive later). For example precious metals, land, works of art, oil, corn, among many other things. Broadly speaking, this class of assets is called commodities. Contrary to what many people think, their price is generally much more volatile, but due to their lower correlation, they can be useful to reduce the risk of our portfolio.
Each of these investment types or asset classes have different risks and also behave differently depending on economic cycles. We will talk more about this in the second part.
Personal Finance Coach
Heritage
Senior executive in insurance and reinsurance with strategic business vision, high leadership, negotiation and management skills.
He is also a Personal Finance columnist in El Economista, Personal Finance Coach and creator of the page www.planetusfinanzas.com