compare and contrast the different types of investments ABM_BF12-IVm-n-23

classify investment according to its type and features, and advantages and disadvantages
ABM_BF12-IVm-n-24

measure and list ways to minimize or reduce investment risks in simple case problems
ABM_BF12-IVm-n-25

enumerate money management philosophies ABM_BF12-IVo-p-26

illustrate the money management cycle and gives examples of sound practices in earning, spending,
saving, and investing money ABM_BF12-IVo-p-2

Investing Fundamentals

The word "investment" has become muddled with overuse. Referring to a stock or a bond as an
investment is still in regular use, but now people make "investments" in their education, their cars and
even their flat screen TVs.
In this article, we will look at the three basic types of investment as well as some of the things that are
definitely not investments - no matter what the commercial says.

Investment, as the dictionary defines it, is something that is purchased with money that is expected to
produce income or profit. Investments can be broken into three basic groups: ownership, lending
and cash equivalents.

Ownership investments are what comes to mind for most people when the word "investment" is batted
around. Ownership investments are the most volatile and profitable class of investment.

The following are examples of ownership investments:

Stocks

Business

Real Estate

Precious Objects

Stocks are literally certificates that say you own a portion of a company. More broadly speaking, all
traded securities, from futures to currency swaps, are ownership investments, even though all you may
own is a contract. When you buy one of these investments, you have a right to a portion of a company's
value or a right to carry out a certain action (as in a futures contract).

Your expectation of profit is realized (or not) by how the market values the asset you own the rights to.
If you own shares in Sony and Sony posts a record profit, other investors are going to want Sony shares
too. Their demand for shares drives up the price, increasing your profit if you choose to sell the shares

Business

The money put into starting and running a business is an investment. Entrepreneurship is one of the
hardest investments to make because it requires more than just money. Consequently, it is also an
ownership investment with extremely large potential returns. By creating a product or service and
selling it to people who want it, entrepreneurs can make huge personal fortunes. Bill Gates, founder of
Microsoft and one of the world's richest men, is a prime example.

Real Estate

Houses, apartments or other dwellings that you buy to rent out or repair and resell are investments. The
house you live in, however, is a different matter because it is filling a basic need. The house you live in
fills your need for shelter and, although it may appreciate over time, it shouldn't be purchased with an
expectation of profit. The mortgage meltdown of 2008 and the underwater mortgages it produced are a
good illustration of the dangers in considering your primary residence an investment.

Precious Objects

Gold, Da Vinci paintings and a signed LeBron James jersey can all be considered an ownership
investment - provided that these are objects that are bought with the intention of reselling them for a
profit. Precious metals and collectibles are not necessarily a good investment for a number of reasons,
but they can be classified as an investment nonetheless. Like a house, they have a risk of physical
depreciation (damage) and require upkeep and storage costs that cut into eventual profits.

Lending Investments

Lending investments allow you to be the bank. Lending Investments tend to be lower risk than
ownership investments and return less as a result. A bond issued 0by a company will pay a set amount
over a certain period, while during the same period the stock of a company can double or triple in value,
paying far more than a bond - or it can lose heavily and go bankrupt, in which case bond holders usually
still get their money and the stockholder often gets nothing.

Examples of lending investments

Your Savings Account

Bonds

Even if you have nothing but a regular savings account, you can call yourself an investor. You are
essentially lending money to the bank, which it will dole out in the form of loans. The return is pitiful,
but the risk is also next to nil because of the Federal Deposit Insurance Corporation (FDIC). (PDIC in
Phils.)

BONDS

Bond is a catchall category for a wide variety of investments from Treasuries and
international debt issues to corporate junk bonds and credit default swaps (CDS). The risks and returns
vary widely between the different types of bonds, but overall, lending investments pose a lower risk and
provide a lower return than ownership investments.

Cash Equivalents

These are investments that are "as good as cash," which means they're easy to convert back into cash.
Short term highly liquid financial instruments that are so near their maturity and that there is
insignificant risk of change in value due to fluctuation of interest rates.

Only highly liquid investments that are acquired three months before maturity can qualify as cash
equivalents.

Examples: 3-month BSP Treasury Bill, 3-month Time deposit, 3-month money market instrument or
commercial paper.

CASH EQUIVALENT- matures 3 months or less from the date of acquisition.

SHORT TERM/TEMPORARY INVESTMENT- matures less than 1 year from the date of acquisition.

LONG TERM INVESTMENT- matures more than 1 year from the date of acquisition.

“Temporary investments in equity shares are not included as part of cash equivalents because these
securities do not have maturity dates. Except for Redeemable Preference share(considered as debt
instrument), it can be reported as cash equivalent if purchased within 3 months or less before
redemption date.”

EXAMPLE OF CASH EQUIVALENT

Money Market Funds

With money market funds, the return is very small, 1% to 2%, and the risks are also small.
Although money market funds have "broken the buck" in recent memory, it is rare enough to be
considered a black swan event. Money market funds are also more liquid than other investments,
meaning you can write checks out of money market accounts just as you would with a checking account.
(For more on black swan events, see Black Swan Events and Investing.)

Close, but Not Quite

Your education is called an investment and many times, it does help you earn a higher income. A case
could be made for you "selling" your education like a small business service in return for income like an
ownership investment.

The reason it's not technically an investment is a practical one. For the sake of clarity, we need to avoid
the ad absurdity of having everything be classified as an investment. We'd be "investing" every time we
bought an item that could potentially make us more productive, such as investing in a stress ball to
squeeze or a cup of coffee to wake you up. It is the attempt to stretch the meaning of investment to
purchases, rather than education, which has obscured the meaning.

Not Investments

Consumer purchases - beds, cars, TVs and anything that naturally depreciates with use and time - are
not investments. As an example, you don't invest in a good night's sleep by buying a foam pillow. Unless
you're very famous, and even then, it's a stretch, since you can't reasonably expect someone to pay
more for your pillow than the initial purchase cost. Don't take it personally, but there's very little
demand in the second-hand pillow market.

5 Investing Risk Factors And How To Avoid Them

By Tim Parker

Investing comes with risks. Sometimes those risks are minimal, as is the case with treasury bonds, but
other times, such as with stocks, options and commodities, the risk can be substantial. The more risk the
investor is willing to take, the more potential for high returns. But great investors know that managing
risk is more important than making a profit, and proper risk management is what leads to profitable
investing.

Each investment product has certain risks that come with it, while some risks are inherent in every
investment. Here are a few to consider.

Business Risk

Business risk may be the best known and most feared investment risk. It's the risk that something will
happen with the company, causing the investment to lose value. These risks could include a
disappointing earnings report, changes in leadership, outdated products or wrongdoing within the
company. Because of the large amount of possible risks that come with owning stock in a company,
investors know that forecasting these risks is nearly impossible. 

Purchasing a put option to guard against a large decline or setting automatic stops are the best ways to
guard against business risk

Call Risk

Some bonds have a provision that allows the company to call back or repay a bond early. They will often
exercise this right if they have to pay a higher coupon on an existing bond than what they would have to
pay at today's interest rates. Although this will not represent a loss of principal, for investors who rely on
a certain coupon rate for their monthly living expenses, this can represent a substantial loss of income.

For those who rely on coupon income for immediate living expenses, investing
in noncallable bonds, bond funds or exchange traded funds is a solid diversification strategy

Non callable bond is A financial security that cannot be redeemed early by the issuer. The issuer of
anoncallable bond subjects itself to interest rate risk because, at issuance, it locks in the interest rate it
will pay until the security matures.
Allocation Risk

Have you looked at your 401(k) lately? You've likely heard that keeping the appropriate asset
allocation is essential to managing risk as you move closer to retirement. Moreover, this summer,
federal disclosure rules are requiring 401(k) providers to disclose fees associated with investment
products. 
The younger you are, the more of your portfolio should be allocated to stocks and as you age, bonds will
slowly become the dominant investment type. Manage your allocation risk and fees related to investing
in your retirement account by investing in a low-fee target date fund. Additionally, ask for the help of a
trusted financial adviser if you don't have the knowledge or experience to manage your own portfolio. 

Political Risk

Investors in commodities like oil understand political risk. When Iran threatened to block the Strait of
Hormuz, investors were concerned that the price of oil would become more volatile, putting their
investment at risk. The Haiti conflict and terrorist attacks on oil pipelines have caused artificial volatility
to enter oil and other commodity markets. Moreover, issues arising in South East Asia pertaining to land
claims, as well as the tensions between North and South Korea, have shaken markets in that region. 

Socio-political risk is difficult to avoid since most events happen without warning, but having hard and
fast exit points as well as hedges are the best way to weather socio-political storms.
Dividend Risk

Dividend risk is the risk that a company will cut or reduce its dividend. This is not only a problem for
those who rely on stock dividends to live on during retirement, but when a company cuts its dividend, it
often causes the stock to lose value, as those who were holding it for the dividend move to other
dividend-paying names.

Reduce the effects of dividend risk by holding a well-diversified portfolio with multiple dividend-paying
stocks. If the dividend is the only reason you're holding the stock, sell as soon as is practical after the
announcement of the change.
The Bottom Line
Every investing strategy will have risks and managing those risks is how to gain the best performance
from your money. Don't reach for higher rewards without first evaluating the risks involved. Seasoned
investors know that it's a lot easier to lose money than it is to gain it.
Money management philosophies

Financial fitness, like physical fitness, is mostly about good habits. “You’re establishing habits and getting
into a routine at an early age,” says Mary Beth Storjohann, certified financial planner and CEO and
founder of Workable Wealth. “So as your income grows and your life gets more complicated as you get
older, you’re already in the routine of setting money aside, tracking your spending, saving for retirement
and you know how to shape and plan for goals.”

Here are three habits to adopt now for financial health:

Spend less than you earn.

This principle is at the core of all good financial management. It’s how rich people get rich.  It’s how
people who aren’t wealthy can achieve their life goals anyway, without scads of money to throw
around. When you spend less than you earn, you save. And what you save becomes wealth.

[This principle] is what makes people not worry about money, because they know they can pay their
bills every month, and if an emergency comes up, they know they have enough in savings. People who
spend more than they earn are going further and further into credit card debt or going into their
overdraft, and that creates a ton of stress,” says Sophia Bera, certified financial planner and founder
of Gen Y Planning.

This was key for me to climb out of debt, stay out of debt, build up my savings and achieve life goals like
quitting my job to freelance, living in Italy for four months, moving to a new city and more.

No matter how wealthy or poor you start out as an adult, this is the secret to maintaining a life of
freedom to pursue your goals. The wealthy, if they live beyond their means, lose their riches, and the
poor, if they do the same, will never escape poverty. While the other two primary financial principles
will make your life a lot easier, this one makes or breaks your life, period.

2. Invest as early as you can.

Everyone’s biggest financial challenge is saving for retirement. It’s the largest amount of money you’ll
have to save in your lifetime, and unpredictable windfalls notwithstanding, the only way to accomplish it
is to save regularly over a long period of time. But if you start to save early on in your career, the
prospect becomes less daunting.

Saving at a young age allows you to take advantage of the power of compounding. If Person A saves
$5,000 a year from age 25 to 40 for a total of $75,000 and then never invests another penny, and Person
B invests $5,000 every year from 40 to 65 for a total of $125,000 invested, assuming 5% growth, Person
A will end up with more than $400,000 by retirement, while Person B will only have $256,000, simply
because Person A started saving earlier, even if she put away less.

“The earlier you start investing, the longer your money is in the market, hopefully giving you a return in
the market, beyond inflation, to set you up for an income stream in retirement,” says Storjohann.
“You’re in an accumulation phase for the next 30-35 years, and you want your money to grow, because
when we’re 65, that’s when we have to turn on the spigot, and all of our funds have to turn into a
paycheck replacement for us. We’re building up one large pot to give us a paycheck for the rest of our
lives.”

So if you want to make saving for retirement a whole lot easier for yourself, start now, if you haven’t
yet. Your mind is probably whirring with excuses at this point—how you really need the money now,
how you’ll start when you make more money, how you can get to it later—but the truth is, there will
always be an excuse. When you get a raise, you may want to save for a house, or maybe you’ll want to
save for a wedding or to have kids, or save for their college education. There will never be an optimal
time to start saving for retirement. You will always have to do it against competing priorities. So learn to
do it at the same time as these other demands on your life. Then, when you’re 65 and you want to
retire, you’ll be so glad you have enough money to live a comfortable life for the next few decades. If
you don’t, then at 55 you may be facing a layoff with a modest nest egg, and you’ll be cursing your
younger self.

3. Earn more.

[Earning more] solves multiple problems,” says Bera. “If you’re used to making $2,000 a month net
income from your day job but you’re able to do part-time work freelance or pick up extra hours on the
weekend, that’s all extra. That’s above and beyond what you’re already making, so if you’ve already
figured out your monthly expenses, let’s say you’re making $500 extra a month—that’s money that can
go to pay down debt quickly or build up savings fast.” Or, you could use that money to go on a trip or
save for a down payment on a home.

Beyond that, earning more has a cumulative effect. The earlier you start making more money, the larger
your future raises will be , since raises tend to kick in as a percentage of your existing salary, which
means more money over your lifetime. “The earlier you can lock in the higher income, the better,” says
Storjohann, “because it’s more money you can set aside for your future as well.”

For me, earning more, which I began to do in my last full-time job by taking on an extra, regular
freelance gig, was also key to getting myself on the right path financially. Not only did it allow me to pay
off my student loan debt in about a third of the duration of my loan repayment plan, but it also allowed
me to accrue enough savings for me to feel comfortable quitting full-time work. Scrimping and cutting
costs only go so far, but an extra $200, $500 or $1,500 a month goes a lot further.

It's remarkable to look back and think that just four years ago I owed thousands on my credit cards,
didn't have a savings account in my name and had never created a budget. Today, I have no debt, a
comfortable amount of savings, a growing retirement nest egg, and I'm still able to afford things that
really matter to me, like going to a friend's wedding in Turkey. I somehow even wrote a personal finance
and career book. To what do I owe my transformation? These three money principles.

TEN PRINCIPLES THAT FORM THE BASICS OF FINANCIAL MANAGEMENT

Principle 1

The Risk–Return Trade-Off—We Won’t Take On Additional Risk Unless We Expect to Be Compensated
with Additional Return

Principle 2

The Time Value of Money—A Dollar Received Today Is Worth More Than a Dollar Received in the Future

Principle 3

Cash—Not Profits—Is King

Principle 4

Incremental Cash Flows—It’s Only What Changes That Counts

Principle 5

The Curse of Competitive Markets—Why It’s Hard to Find Exceptionally Profitable Projects

Principle 6

Efficient Capital Markets—The Markets Are Quick and the Prices Are Right

Principle 7

The Agency Problem—Managers Won’t Work for the Firm’s Owners Unless It’s in Their Best Interest

Principle 8

Taxes Bias Business Decisions

Principle 9

All Risk Is Not Equal—Some Risk Can Be Diversified Away, and Some Can Not

Principle 10

Ethical Behavior Means Doing the Right Thing, but Ethical Dilemmas Are Everywhere in Finance

Earning, Spending, And Saving: The Building Blocks Of Personal Finance

A couple of weeks ago, Robert Brokamp explained how living below your means is like saving for
retirement twice. On the surface, his advice was pretty conventional: The more you save today, the
more you’ll have tomorrow. This is similar to a point I’ve been repeating for the past five years.

Smart personal finance can be reduced to one simple equation:

[WEALTH] = [WHAT YOU EARN] – [WHAT YOU SPEND]

If you spend more than you earn, you have a negative cash flow. You’re losing wealth and in danger of
going into debt. (Or, if you’re already in debt, you’re digging the hole deeper.) If you spend less than you
earn, you have a positive cash flow, which will let you climb out of debt and build wealth.

But as I was editing Brokamp’s article, I had a flash of insight. What Brokamp was trying to say — and
what my little equation tries to quantify — is that basic personal finance comprises three essential skills:

Earning — your ability to bring in money.

Spending — your ability to live frugally and spend wisely.

Saving — your ability to produce a surplus and to make that surplus grow.

Some folks are good at one skill, but not the others. (Maybe you’re good at keeping your costs low, for
instance, but struggle to earn money.) Other people are good at two of the skills, but fall down on a
third.  (You might have a good income and keep your costs low, but have a small nest egg because you
lack skill in saving.) And still others are passable at all three skills — not really excelling, but not failing
either.

To be truly successful at personal finance, you have to maximize your performance in all three areas.

Mastering the Art of Earning

Here are some steps that lead to increased earning:

Become better educated. In general, the better your education, the better your income.

If possible, choose a career that you love — and that pays well. This isn’t always possible, of course. But
if you can get paid well to do what you love, it can almost be like you don’t have a job at all!

Maximize your salary. This is probably your primary source of income, so make the most of it. Learn how
to negotiate your salary. Make the most of your benefits.

Make money from your hobbies. Find ways to earn a little cash from the things you do in your spare
time.

Turn your clutter into cash. When I was getting out of debt, I sold tons of Stuff previously bought on
credit. I didn’t get back what I paid for it, but that’s okay. I got out of debt, which was even better.
(Here’s more about selling your stuff.)

Though some people don’t like to hear it, high income is also associated with hard work. The folks who
make the most money are often those who work the longest hours. Hard work doesn’t guarantee a high
income, of course — there are plenty of hard workers stuck in low-wage jobs — but it’s tough to master
the art of earning withouthard work.

And here’s another reason to enhance your earning power: As vital as it is to cut your spending, there’s
only so much you can trim from your budget. Your income, on the other hand, is theoretically unlimited.

If life were a game, your earning score would be easy to calculate: It’d simply be a measure of your
annual income. The more you made, the higher your score.
Note: For more on this subject, see my colossal post about how to make money. It’s a huge list of ways
to boost your income.

Developing Discipline in Spending

While some people find it tough to boost their incomes, others find it tough to keep costs down. There
are even those who believe that thrift is overrated, that it’s somehow akin to deprivation. But those who
dismiss frugality to focus solely on earning are missing a key piece of the puzzle. Your goal should be
to create as big a gap as possible between earning and spending.

How do you do that?

Embrace frugality. A lot of folks are afraid to pinch pennies — they don’t want to appear cheap —
but frugality is an important part of personal finance. Learn to clip coupons, shop at sales, and make do
with less.

Practice conscious spending. You can’t always get what you want, so decide what’s important to you,
and make those things a priority. Cut corners on the things that don’t matter.

Avoid paying interest. The power of compound interest can help you build wealth when it’s on your
side. But it can suck you dry if it’s working against you. To cut your interest payments, Get out of
debtand stay out of debt. Make it a goal to pay as little interest as possible.

Reduce recurring expenses. One-time costs can be painful, but ongoing expenses — like magazine
subscriptions, cable television and cell-phone bills, etc. — can act like an anchor on your finances.

Focus on the big wins. Daily frugality is a valuable skill. It helps you save a little bit all the time. But if
you really want to cut your spending, spend less on the big things, like housing and transportation.

If personal finance were a game, your spending score would come from how low you could go. The less
you spent, the higher your score.

Remember: Your earning power might bring you wealth; frugality and thrift will help you keep it. By
cutting your spending while you increase your income, you’ll develop a cash surplus — a surplus that can
be used for saving.

Note: For some reason, financial writers often fixate on spending. There’s no question that it’s
important, but it’s not the only piece of personal finance. It’s one of three basic building blocks. If you
embrace frugality but ignore your income and investments, you can’t expect to build wealth. Each skill is
essential.

Discovering the Secret of Saving

Often when I write about saving, I’m just talking about the difference between what you earn and what
you spend. This surplus is important, no question — it forms the foundation of your ability to save —
but skill at at saving comes mainly from what you do with your surplus.
If you hide your money under a rock, for instance, your skill at saving isn’t particularly good. Anyone can
do that. And though you might think you’re protecting what you’ve saved, you’re actually losing money
to inflation, the silent killer of wealth. (If you use your extra money to play the lottery, I’d argue that
your savings skills are especially poor!)

What sorts of things go into becoming a successful saver? This is where a knowledge of investing pays
dividends. The secret of saving is to learn everything you can about making your wealth grow. Successful
savers:

Understand the importance of creating a plan — and sticking to it. (This is where asset allocation and re-
balancing come into play. I’ll write about these more later in the month.)

Make logical decisions instead of succumbing to emotion. Successful savers don’t make decisions based
on breathless media pundits.

Avoid fads. They don’t buy real estate just because everyone else is. They don’t buy tech stocks just
because they’re riding high. And they’re wary of gold when it’s at record highs. They buy low and sell
high.

Embrace diversification as a way to improve returns while reducing risk.

Constantly contribute their surplus income to grow their savings. They pay themselves first.

If there were a scorecard for life, your points for saving would be determined by how much you make
your surplus grow, and by how well you protect the money you save.

Note: I used to do a poor job with all three of these skills. Over the past few years, I’ve become adept at
earning, and I’m learning to be a better saver. My spending skill is improving, but remains the weakest
part of my personal-finance package.

The Fundamentals of Personal Finance

None of this is earth-shattering; these notions form the core of smart personal finance. What is new —
for me, anyhow — is thinking of earning, spending, and saving as discrete skills, building blocks that can
be put together to form a greater whole. It’s this framework that’s new.

Mastering money means mastering each of these three skills

If you can teach yourself all about earning, spending, and saving — and put what you learn into into
practice — you’ll achieve your financial aims with surprising speed. But so long as one of these skills lags,
you’ll struggle to meet your goals.