Basic Investment Principles

If you have never invested money in stock markets before you might wonder about where to start. It isn't as hard as you might think if you follow certain principles and rules. These in turn should be in line with why you are in the stock market in the first place, and what your investment objectives are.

Ok, let's start with the latter. Each serious investment advisor will ask you for your investment objectives. He/she will also ask other questions to asses your relation to risk, your free income, your other assets, etc. It is important to gain an overall understanding of you individual situation. For instance, if you know that you want to buy a car in a few months, shares usually are not the ideal choice. A term deposit with your bank might be the better investment.

If on the other hand you already have bought a house (sure, there is still that morgage to pay off) and you have a job, you have quite some money in short term investments, e.g. on call accounts, then it might be worthwhile to look at longer term investments. Shares are always a long term investment if you really want to benefit from it.

Risk

There is no such thing as a risk free investment. Let's assume you keep your cash at home. What is the risk? Even if your home doesn't burn down and nobody steals it you still have a risk. It is called inflation. Or in other words: While you keep your cash at home prices for goods you would buy increase. This means that you can buy less for your cash. Your money has lost buying power or in other words: it has lost value. So keeping it at home is not necessarily a good risk.

Let's try a savings account. You put your money in the bank and you get interest for it. Let's assume you get 4% interest on the money in your account. Now what is your tax rate? Is the income from interest free in your jurisdiction? If you are an honest tax payer you have to pay taxes in all likelyhood. 20% or 30% is probably the standard. In some countries you may pay a lower tax rate but maybe you have social security to pay as a percentage of your income. Lets assume you have to pay 25% overall. For the 4% interest rate this means that you actually have 3% after tax. If your inflation is near 2% then all that is left is 1% of your interest. That's pretty meager.

If you then compare it with a fund like the Templeton Growth Fund [1] which has had an average annual total return since 1954 of 11.3% (8.475% after 25% tax) then you may want to ask whether 1% is acceptable.

The other extreme might be a lottery. You "invest" a small amount of money. If you happen to be the lucky winner you will become a millionaire. Your "interest" is enormous. But what is the risk? Most of the people (99%) will never become millionaire but they will happily buy a new lottery ticket every week. Now just total up that money and put a 9.75% interest on it. Do the maths for 10 years.

Bottom line, there is no risk free investment. There are only different combinations of risks and return. And it is important for you to understand how much risk you are willing to take.

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[1] We have no business relationship and no financial interest with Templeton Growth Fund.