WHERE TO PUT YOUR MONEY?
October 1, 2006: Money should not be kept idle. Once we have some extra money, we need to invest it
so that we can generate some extra income out of it. Generally assets are of two types. They are
financial assets and real assets. Examples of the financial assets are stock, bond, mutual fund, fixed
deposit etc while real assets are land, house, car etc. This section will discuss primarily about the
prospects and challenges that are linked with financial
assets.
First of all, we need to buy some books on investment issue and acquire some basic knowledge about
stock, bond, mutual fund, fixed deposit account etc. In addition to that, we can talk to a financial planner
to exchange our views and acquire knowledge before investing money. Many companies in recent days
provide free financial advice for us. Companies who are issuing bond and stock usually publish their
prospectus where we can see all their activities including asset and liability of the company, sale volume,
nature of the business etc. We can indeed gather knowledge from the prospectus.
As said, there are a number of financial instruments that are available in the financial market for our
money gets invested. The most popular financial instruments are stock, bond, mutual fund and fixed
deposits. Before deciding of the investment, first of all, we will have to know what type of person we are.
Are we risk lover? Can we invest money for long term?
If we want to have higher total return from financial assets, we will have to invest money in stock but
investment must be made for a long term. Experiences and statistics suggest that total return from
stocks is higher than any other financial instruments but money must be parked for a long term in that
particular stock portfolio. Stock portfolio is an accumulation of stocks that you are holding. Best
suggestion is to buy all blue chips and keep it for next 10 years.
Total return from the bond is guaranteed if you can hold the bond until maturity. Investment in bond is less
risky compared to stock as the interest and principle payment by the bond issuer is guaranteed. But total
return from bond is lower than stock, on average.
When the Central Bank increases interest rate to take the excess money out from the financial system to
tackle inflation, prices of stock go down due to shortage of money supply in the financial system. This is
the best time to buy stocks. Our profit always lies with the purchase. If we can purchase at lower price,
profit is almost certain. On the other hand, yield of the bond goes up with the interest hike. When the
bond yield goes up, price of the bond always goes down. In this case, we can hold the bond until maturity
to get interest (coupon rate) plus principle. The best suggestion is to keep the bond until maturity and
meanwhile we can enjoy higher yield. Indeed, there exists an opposite relationship between price of the
bond and its yield.
When the Central Bank reduces the interest rate in the economy to tackle recession, money supply
increases in the financial system. This increased money supply enhances demand for stock and hence
stock prices shoot up. This is not good time to purchase stock but good time to sale. On the other hand,
due to low interest rate, yield of the bond goes down while price of the bond goes up. We better sale the
bond now at higher prices and reinvest the money in a higher yielding bond.
Central Banks around the world are maintaining foreign reserve to defend their currencies as well as to
take part in international trade. Suppose the Central Bank of Malaysia is currently holding about US $80
billion as foreign reserve. The largest portion of this foreign reserve is invested in US treasury securities
(bond). Not only Malaysia, the largest portion of the Asian foreign reserve is invested in US treasury
securities. Why US treasury securities? because the US government has never been defaulted to pay
the money back as soon as the securities get matured. Investment in the US treasury security is the
safest in the world. The Federal government of the United States borrows money through securities
(bond) to meet its deficit, which is very common in the years of American history.
So, when the US currency depreciates, the value of the US treasury security (bond), kept by the Asian
Central Banks gets squeezed. In recent years, US dollar is depreciating against all major currencies. As
a result, Asian Central Banks are confused whether they should keep reserve in dollar denominated
security (bond). With the dropping US dollar value, investment in US treasury may get squeezed. The
reduction in investment is likely to affect adversely the capital account balance of the United States. As
for information, US is always experiencing a huge current account deficit and this deficit is largely met by
the surplus of the capital count balance since long.
So if the US dollar continues to have a very steady decline, we should not put our money is US dollar
denominated security or bond. Since United States is a potential economy, its dollar value will not
continue to fall and its value is likely to shoot up in near future. Current sluggishness in dollar value may
be a temporary one.
There are prevailing a number of financial agencies/companies, who are grading bond issuing
companies or grading on a particular bond time to time. Investor can purchase bond on the basis of the
grading rate. Historically, we have observed that established companies are paying lower interest rate
compared to newly growing companies against their bonds. Although interest income paid by the
established companies is low, they have stability and credibility. Amount of interest income is not
important. Important is its ability to pay interest and principle. Established companies or bonds are
usually enjoy higher grading rate given by Moody, Standard and
Poor etc
If we buy or sale stock or bond from the market, we need to pay fees to brokerage house meaning that
our return gets squeezed with this payment. To avoid this cost, we can invest money in mutual fund.
Mutual fund is a fund which consists of various types of financial instruments ranging from stock, bond to
fixed deposit. Various types of financial instruments are accumulated to diversify the investment in order
to spread risk. Mutual fund is managed by a group of fund managers who use their expertise and
experiences to invest our money in various financial instruments. The good news lies here, we do not
need to pay any brokerage charge to sale or buy our financial instruments once we become a member
of a mutual fund. The money invested in mutual fund can be converted to cash any time. At the same
time, money or profit can be reinvested without any fees.
The most secured investment is to put the money in a fixed deposit account. If we are risk averse, we
can put our entire saving in fixed deposit account and continue to enjoy return. But the return from fixed
deposit is lower than bond and stock. In other words, lower the risk attached with financial instruments,
lower the return is expected and vice versa.
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