Congratulations! If you’re reading this article then you might have just taken your first steps towards financial freedom.
In the Philippines, it has been reported that less than 1% of the total population invest in stocks. The fact that you’re reading this means that you are interested in being among the 1% -- you’re interested in making a better life for yourself by letting your money work for you.
Although it is true that a stock investment can have great returns, it isn’t the only thing that you can invest your money in. There are different asset classes that you can consider, each with characteristics and risks specific to that class --- and unless you’re Warren Buffet v2.0 or a Wolf of Wall Street (minus the sketchy history of deals, hopefully) , you won’t be trading your day job for the yacht right away when you start investing. Investing, like many other things, require a lot of effort and time spent in learning before you rake in your gains, if any. While this article is not meant to be a complete guide, it should be enough to be your baptism to the crazy world that is making more money with your money.
The basics
Generally, an investment can be in either equity or debt. An equity instrument is just a fancy term for something that represents an ownership stake. The best example for which is the stock. To put it simply when you buy the stocks of a corporation, you become an owner of that corporation. You can receive dividends, net assets at liquidation and vote at important company matters. You actually earn a seat with the big boys during annual meetings when you own stocks!
This ownership, as evidenced by the stock certificate, entitles you to the excess earnings of the corporation in the form of dividends. Dividends are what the corporation hands out to its investors (usually in cash) which becomes the investors own earnings.
Another way a stock investor earns is when the stock price increases (or capital appreciation). If the buying public thinks that one company is doing well, the demand for that company’s stock increases resulting to that stock being priced higher than before resulting in an unrealized gain.
It’s unrealized simply because the investor hasn’t received anything as a result of a stock price increase. To cash in his gains, he can simply sell off his stock. This is taken in consideration with the company’s prospects as there are valid practices of speculating a stock’s future performance.
The other general form of investment is debt instrument, or simply debt. A lender typically charges interest when he shells out money and this mainly how people earn through lending. A debt instrument is best represented by a bond indenture. A bond is a promise to pay a stated amount at a certain date with a stated interest rate. Usually, a bond is issued by a company when it needs additional funding for new projects because it is cheaper to raise debt than to add more owners. Bond and other debt holders are paid there due before stockholders get their dividends, among other priorities.
What makes them different, exactly?
When you buy a stock, you become an owner. When you buy a bond, you’re a lender. That’s the simple difference. However, this doesn’t paint the full picture exactly. What makes the gap between bonds and stocks apparent are their relative risks. But first let’s discuss them in more detail.
There are two main kinds of stocks: preferred and common. Preferred stocks get their name because they are prioritized over common stocks when it comes to earnings and dividends. Usually, preferred stocks get a percentage of their par value. Think of the par value as the minimum price that a stock can be sold for (It’s actually in the stock certificate). So if a P100 Preferred stock has a 6% stated rate, the owner of that stock is actually entitled to P6 in dividends subject to conditions attached to that stock.
Common stocks or ordinary stocks, on the other hand are called as such because they don’t enjoy any priority. The magic of owning a common stock however, is that there’s really no limit to what you can earn --- except for the company’s performance and management’s decisions.
Sounds confusing? It really isn’t. For example, a company’s preference shareholders are entitled to P10,000 in dividends. As long as the company has earnings that exceed that amount, the rest , which can be substantially higher, will be shared by common shareholders, From the same example, if the company has a million in excess earnings, the common shareholders will be sharing P990,000 among themselves. However, this also makes common stockholdings more volatile as they also carry the equal risk of not earning at all in dividends. Since they only get what’s left, what if there’s nothing at all to share? That’s why stock investors demand higher returns for higher risks.
Bonds remain largely the same for all cases but what you can earn depends on the kind of entity you’re investing in. Aside from corporations, you can actually buy bonds issued by the government (Treasury bonds). Bonds , however, are associated with less returns. This doesn’t mean that they’re worse than stocks. Since bonds are ‘safer’ because of the priorities they enjoy as mandated by law, the lower returns are actually justified since they carry less risk.
On risk : Stocks are like Shoes
If the risk and related returns are still hazy concepts to you, here’s a simplistic approach in imagining risk. Think of investment options as different kinds of shoes you would wear. Naturally, you’d be inclined to wear comfortable footwear such as flats. When wearing sneakers or flats, you don’t have to worry about getting your feet hurt. However, they might be less underwhelming in terms of aesthetic value and some are just plain, ugly and boring.
The same goes for investing in securities. Most of us will tend to gravitate to less volatile securities with lower returns because we are risk averse. However, by picking only low-risk assets, we leave much room to be wanted in profits. We begin to wonder if we could get away with more ‘out there’ choices , like how we think about our shoes. Stilettos are like volatile assets, and some just have the guts to use only them in their wardrobe. By using only them, your feet will always hurt and the shoes themselves might even crash under your weight. But they do look amazing and in fact, they have their use. Heels, be it in suede or velvet, make you taller and more confident, and some people would shell out a lot of money just for the latter alone.
When buying shoes, people might have their favorite types but they tend to end up with a diverse collection of shoes. The same goes for when they build their portfolio of investments. Sure, if you really really like one particular company, you can go all out on that company. Granted, that would be totally unwise and over the top risky. Holding only one kind of asset does not give you a fallback for when things get rough in that company / industry. When selecting investments, it’s actually best to practice Diversification. Some risks are specific to industries --- like food poisoning in the food industry ---- but we can actually offload some of these risks by investing in assets that don’t exhibit such risks. If you have investments in food and technology, your losses in one could be offset by gains from the other.
By adding a different security from a different industry, you actually end up having more returns than the risks that you carry. The same way goes with shoes, you can have ten pairs of flats but by keeping a few platforms or brogues, you’re sure that you have something when one of them is ruined or is not appropriate. To maximize your own benefits, you should create a portfolio that matches your risk appetite.
I know about risks now. How do I actually start trading?
The country has only one stock exchange, the Philippine Stock Exchange. It acts as an intermediary and as facilitator to accredited trading bodies. However, in order to start trading. You must open an account at a stock brokerage firm. Stock brokers buy and sell for both retail (individual) and institutional clients. Stock brokerages in the country include COL Financial, FirstMetroCorp and BDO Nomura.
With the basics fleshed out, it’s high time to actually know how to open an account and start trading.
