During my last eight lectures I have discussed different ways of saving for both expected and unexpected eventualities; this has included debt reduction, mortgage deposits, different insurance packages and retirement planning. These savings plans have been designed to provide you with key building blocks for a prosperous and financially secure future. It is now time to learn about investing, which concerns making more money out of your invested money. In a sense, winning more than you lose.
And with your active participation, I can help you become a successful investor. The trick is to think about the big picture - where the world is going and where we are going with it. Investing is not really that difficult. You may think that the so-called professionals are smarter than you, but much of this may have to do with complicated investment terminology - it keeps a certain distance and mystique associated with "superior skills." Unfortunately, many of these skills have been exercised at the expense of the investing public. Nevertheless, all of us are capable of creating an investment portfolio - on our own and partly with the help of professionals - that matches our needs.
Remember these key points: think ahead and make an effort; understand time and money; invest wisely; and consider risks. Investing is a large subject and portfolio construction requires planning. It does not only include buying and selling bonds and shares. Your portfolio may include property (apart from your home), mutual funds, commodities and even collectables. But just because it is a large subject, does not mean that you cannot grow wealthy from putting away just a few hundred dollars a month for investing.
For example, if you manage to invest US$500 (Dh1,836) per month, with an average annual return of 5 per cent, you will be sitting on more than $77,500 in just 10 years. This demonstrates the results of applying time and money. Now see what happens if you apply wisdom as well: if your average annual rate of return is instead 10 per cent, you will be sitting on more than $102,000 over the 10 years. And if we take this one step further by commencing our investment plan when we are 35 years, our nest egg will be nearly $380,000 by the time we are 55.
This is known as the "power of compound returns" and further illustrates that investing monthly is more effective and less burdensome than investing in lump sums (you might be interested to know that Albert Einstein called compound returns the "eighth wonder of the world"). You should understand that risk comes with investing your cash - even in a wisely assembled portfolio. But keeping your money under your mattress is also risky.
First of all, it does not grow - at least cash deposits with your bank pay you interest. Secondly, the cash under your mattress will slowly fall in value as the cost of goods you require to buy rises; this is known as inflation. So, if you are going to keep your cash on deposit with your bank, calculate how much interest you earn against the annual inflation rate. Remember the basic mantra: the higher the return you want to achieve, the greater the risk you will have to take.
It is also important to remember that investment risk comes in two forms: specific risk and market risk. Specific risk applies to the particular item you are investing in, for example a share. There are many different types of shares to invest in and they range from blue chips to speculative shares and each carries varying degrees of risk. Market risk, on the other hand, results from global conflicts, political turmoil and, most recently, from the credit crunch. Such occurrences will affect even the very safest investments.
Next week, we are going to look at risk as part of a wise investment strategy. John McGaw is a financial adviser based in Dubai. Contact him at jmcgaw@emirates.net.ae
