Investing 101

Albert Einstein is credited with saying that compound interest is the 8th wonder of the world.

Legendary investor Warren Buffett defines investing as “the process of laying out money now to receive more money in the future.”

The aim of investing is to put your money to work in one or more types of investment vehicles in the hopes of multiplying your money over time.

When most people think about investing, they imagine they need a million francs to begin. So they pay little attention to ”investing” and focus more on ”saving”. Do you know why that is problematic? Two reasons- one, the idle cash in your bank account is an opportunity cost as it cannot earn more money, and second, it does not have the potential to beat inflation.

Over time, inflation reduces the purchasing power of cash. If the current inflation rate is 4%, when you spend the 100 franc bill you stashed in a cookie jar last year, that money will only get you 96 francs worth of groceries compared to what it would have bought you the previous year. In other words, the idle cash doesn’t buy as much as it used to because everything has gotten 4% more expensive.

Now you know it’s possible to save money and lose money — that is, spending power — at the same time. You now want to understand how your long-term investments can outpace inflation, right? Well… you should invest in the stock market.

One look at the historical rate of return of the major asset classes shows that the stock market will give you the biggest bang for your bucks. Despite the stock market’s far superior returns, many people are not investing.

Many people think it’s too risky or investing is difficult. While this is a compelling concern, and investing is a risky business like any other, having a diverse portfolio can help you navigate the market and ultimately achieve your goals.

The investment landscape is constantly evolving. But those who take the time to understand the basic principles and the different asset classes stand to gain significantly over the long haul. Imagine the various asset classes are rungs on a ladder. We will explore some major asset classes and their risks in order.

Cash

A cash bank deposit is the simplest, most easily understandable investment asset—and the safest. Not only does it give investors precise knowledge of the interest they’ll earn, but it also guarantees they will get their capital back.

On the downside, the interest earned from cash socked away in a savings account seldom beats inflation. Interest at the bank is at all-time lows.

Bonds

A bond is a debt instrument representing a loan made by an investor to a borrower. A typical bond will involve either a corporation or a government agency, where the borrower will issue a fixed interest rate to the lender in exchange for using their capital. Bonds are commonplace in organisations that use them to fund operations, purchases, or other projects.

Bond rates are essentially determined by interest rates. Due to this, they are heavily traded during periods of quantitative easing or when the central banks—raise interest rates.

Mutual Funds

A mutual fund is an investment where more than one investor pools their money together to purchase securities. Mutual funds are not necessarily passive, as they are managed by portfolio managers who allocate and distribute the pooled investment into stocks, bonds, and other securities. Individuals may invest in mutual funds for as little as 1,000 francs per share, letting them diversify into as many as 100 different stocks contained within a given portfolio.

“Saving money for retirement is not enough; you need to invest for it to grow.”

Exchange-Traded Funds (ETFs)

Exchange-traded funds (ETFs) have become quite popular since their introduction back in the mid-1990s. ETFs are similar to mutual funds, but they trade throughout the day on a stock exchange. In this way, they mirror the buy-and-sell behaviour of stocks. This also means their value can change drastically during a trading day.

Stocks

Shares of stock let investors participate in the company’s success via increases in the stock’s price and through dividends. Shareholders have a claim on the company’s assets in the event of liquidation (that is, the company going bankrupt) but do not own the assets.

Holders of common stock enjoy voting rights at shareholders’ meetings. Holders of preferred stock don’t have voting rights but do receive preference over common shareholders in terms of the dividend payments.

Alternative Investments

The expanse of alternative investments is vast and covers the following sectors:

Real estate: Investors can acquire real estate by directly buying commercial or residential properties. Alternatively, they can purchase shares in real estate investment trusts (REITs). REITs act like mutual funds wherein a group of investors pools their money together to buy properties. They trade like stocks on the same exchange.

Hedge funds and private equity funds: Hedge funds, which may invest in a spectrum of assets designed to deliver beyond market returns, are called “”alpha.”” However, performance is not guaranteed, and hedge funds can see incredible shifts in returns, sometimes underperforming the market by a significant margin. Typically, only available to accredited investors, these vehicles often require high initial investments of 1 million francs or more. They also tend to impose net worth requirements. Both investment types may tie up an investor’s money for substantial periods.

Commodities: Commodities refer to tangible resources such as gold, silver, crude oil, and agricultural products.

Allow your savings to take a ride in a vehicle for as long as possible and watch it become more valuable than when you started. It’s like reverse inflation: The fondue you could buy for 1 franc when you were a child would cost you 5 francs decades later. But you can’t store the 1 franc fondue away for years and sell it when it’s worth 5 francs. Instead, you can buy shares in a couple of companies involved in making that fondue — the cheese manufacturers, packaging producers, retailers, and restaurants and reap the rewards of their growth right alongside them.

Stop waiting until you have enough time or money or for the stock market to rise or fall. Stop that. Investing ensures present and future financial security. It allows you to insulate your wealth from inflation and enjoy the benefits of compound interest.