In the first part Personal Finance 1.0 we understood that investing is one of the main components of personal finance, along with saving.
The investment aims to make our money work, supporting other companies/individuals with the hope that these entities will increase production and value over time, and consequently our investment will also grow in value.
An investment, therefore, translates into the purchase of an asset. This asset is purchased (buy) and then held for a variable time (hold) and finally sold (sell) to make a profit. The profit is greater the higher the difference between the purchase price of the asset and the selling price. At this point, it is necessary to clarify some aspects:
- Examples of assets: what to buy.
- Risk: every asset carries an intrinsic risk and one derived from the type of market.
- Strategies: there are different investment strategies, depending on risk, availability, etc…
Asset
There are various types of assets, some simpler, i.e. with easy-to-understand mechanisms, and others more complex that use derivatives and predictions on future market trends.
Let’s try to analyze the most common types of assets. Each asset is often associated with a type of risk, i.e. how easy it is to lose the invested money. The risk derives from different factors, geopolitical situations, volatility of the asset (quantity traded daily, the higher it is, the greater the risk), history of the asset, sector, and many other factors.
Remembering the risks associated with investment is essential for making intelligent and targeted operations.
Revenues and Risk are strictly related
So let’s see a non-exhaustive list of the main and simplest assets
ETF
Exchange Trade Found, are passive investment funds that contain a basket of underlying assets. Essentially if you buy an ETF that follows the S&P500 index, the ETF has all the S&P 500 stocks inside it. The associated costs are very low (TER) compared to a mutual fund, as generally, following an index, they have very low management costs. For the buyer it is like buying a stock, you can buy and sell it easily.
Mutual Fund
Indicates an intermediary institution that takes the investor’s money and invests in a basket of goods. Generally, they have high management costs because there are specialists who define the fund’s strategies.
Real Estate
The brick, which we know well in Italy is another type of asset. Real estate often requires substantial initial capital, which often represents an insurmountable entry barrier for those at the beginning of their journey.
Bonds
Bonds are issued by companies, or more frequently by the state, with such a contract whoever issues a bond undertakes to return the invested money with a well-defined interest rate at the expiry of a well-defined period.
State ones are divided according to maturity, presenting lower risk and lower returns.
Stocks
Stocks are small parts that the company makes available to the shareholder in exchange for money. When you buy a stock, you effectively buy a small percentage of the company.
Purchase strategy
There are generally two philosophies, those who prefer to invest everything immediately and those who invest month by month. Historically, it is better to invest everything you can immediately (lump sum).
Obviously, when you start approaching the world of investments, the amounts available are not so high.
Another excellent strategy, which also mitigates market fluctuations, is therefore dollar cost averaging. This strategy is very simple, invest periodically (once a month), always the same amount on the same assets. The time depends on the person, but you need to take into account the cost of each purchase. Too frequent purchases can lead to transaction costs higher than earnings.
How I invest
What I do as a layman in this world is to follow this division. 80-20, i.e. 80% of my invested assets in Stocks and 20% in bonds. For novices like me, a more prudent 60-40 strategy is often recommended.
The assets I invest in, on the other hand, are accumulation ETFs with world geographic diversification, i.e. distributed worldwide. I use ETFs because they have very low management costs.
For “fun” I have some stocks of individual companies. I also have a very low percentage < 1% of Cryptocurrencies.
Robo advisor
These are investment methodologies that use automation to reduce management costs.
Essentially there are specialists who manage the strategy, portfolio adjustments are then automatically executed according to the chosen strategy.
They are a middle ground between an investment fund and an ETF. They have intermediate costs between the two, which decrease as the invested capital increases. I recommend taking a look, if interested, at:
Both also act as tax substitutes, i.e. they automatically pay taxes on returns.
Practical notes, how to invest
How do you invest? There are two ways:
- Go to your bank, crazy costs in my opinion
- Open an account with an online broker
A broker is an entity that has the ability to make investments, it is an intermediary. The broker earns from our operations! It doesn’t matter if we earn billions or lose all our money, it’s just a platform.
Using a broker is very simple
- Go to the website
- Register (authentication with personal identity documents is required)
- Upload the money you want to invest
- Buy an Asset
- Sell an Asset
NOTE
Make sure that the brokers you use are certified and secure, have a history, and are solid.
One distinction I made initially was to choose a broker that acted as a tax substitute, i.e. that paid taxes on returns for me. Examples of brokers: directa, degiro, and interactive broker.
Taxation
Be aware that some assets, such as ETFs, can be accumulation or distribution, what does this mean?
- Distribution: they pay periodic coupons, the dividends of the companies included in the basket. They can be useful for those who need additional monthly income. Be careful that you have to pay a tax when dividends are distributed. This also happens with single stocks, for example, Coca-Cola distributes dividends and when this happens, they are credited to your account with the broker and are then taxed.
- Accumulation: automatically reinvest dividends. They are fiscally more efficient because taxes on dividends are higher.
And then?
Making a passive buy-and-hold investment is already a good first step, but for the more daring, the world of value investing opens up, i.e. the practice of taking individual companies and evaluating them. Decide whether a company is undervalued by the market and whether it is worth buying or not. When to sell, what numbers to look at in financial statements?
Stay Tuned.
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