For example if you have a fixed deposit and every year you remove the interest and spend it.
Please click on "click to edit" and then enter your information.
How to calculate the interest in your loan
Fixed and variable interest.
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Tuesday, July 28, 2009
How to calculate simple interest on an investment or a loan
This calculator will enable you to determine simple interest on a principal and the amount that will be left after a certain time. This is applicable in case you remove the interest for spending.
For example if you have a fixed deposit and every year you remove the interest and spend it.
Please click on "click to edit" and then enter your information.
How to calculate the interest in your loan
Fixed and variable interest.
For example if you have a fixed deposit and every year you remove the interest and spend it.
Please click on "click to edit" and then enter your information.
How to calculate the interest in your loan
Fixed and variable interest.
Thursday, July 16, 2009
The different types of mutual funds
This is the second part of a series on mutual funds . Like i said on the previous post, mutual funds are the investor's best friend. Especially if you want the easy approach to investing. However mutual funds come in a range of flavour ranging from the safe and conservative one to the risky and high yield ones. As a result in order to understand what type is better for you, you will need to understand the concept of risk and risk tolerance. That is how much risk can you accept in you investment.
The simple rule goes like this. The riskier the mutual fund the higher the risk and the more conservative and safe it is the lower the return.
What are the types of mutual funds?
1. Equity Funds
Equity funds invest only in equities. However you may have funds that invest across the board or you may have funds that are more specialised. Some funds invest in all different types of companies and of all sizes and as a result offer some diversification. However some mutual funds invest in special sector of the economy such as green, gold or technology. Others might invest only in large, medium or small caps companies. While these funds may offer some potential for growth it is unwise to invest all your money in a fund that invest in one sector or one type of company only. If you are really interested i would suggest investing only a small amount like 5 % of your money.
I would strongly suggest investing in a fund that offer some diversification in different sectors and in different company sizes. If you are really interested invest a small part of your money in a fund like gold, green , etc that has some growth potential.
2.Bond Funds
as I have mentionned in the post on deversification and in the post on bonds, bonds offer some advantage to the investor. Bonds can bring some stability to your portfolio and bring regular income in opposition to stocks which may not give regular payment as dividends payment depend on management. A bond fund would thus invest in bonds and since bonds pays biannual coupon payment the bond will give you regular payment.
A bond fund is thus the ideal investment for a retiree for example who would have had to invest in bonds so as to be able to generate regular income. Otherwise he would have had to design a bond ladder which may be beyond the normal investor's capacity.
Like equity some mutual funds invest accross the board in a wide range of bonds of various maturity, risk and issuers. This afford some diversification and risk reduction.
However there are also a lot of mutual funds that invest in a lot of different types of bonds. some would invest only in corporate bonds, muni bonds, government bonds, junk bonds, etc. These bonds may offer some great returns but because they are specialised there is greater risk. I would advise you to invest only in a general bond fund or to invest only a small amount of money in a special fund that you like. However remember that the most fund you invest in, you increase the fees and commissions that you have to pay annually.
3. Money Market Funds
The money market is the market that deals in the trading of short term securities. That is securitie that mature in one year or less such as treasury bills, cds, etc. As you might guess such securities would offer the lowest yield but are the most secure and safe. There is no chance that you can lose your money with a money-market mutual fund. If you have some money that you cannot afford to lose but you want to earn something with it until you need it then the money-market fund is ideal for you. It gives more earning than the CDs or savings accounts.
4. Balanced Funds
The balanced mutual fund can be said to be a mixture of the equity and bond mutual fund. It provide the advantage of long term growth and gain from stocks and the possibility of regular income with bonds. I would therefore strongly reccomend this type of fund for the average investor since it provide the advantages of both stocks and bonds.
Or you could buy in one general bond fund and one general equity fund.
5. Index Funds
The index is simply an index fund that is trying to emulate another index. For example an index fund can have the same shares of all the companies in the Dow Jones. The fund will thus rise and fall in value with the Dow Jones. You can read a post here on index fund.
This is also a good way to invest. Since stocks grow in the long term an index fund will grow in value with time.
6. Speciality funds
These mutual funds invest in stocks or investment instruments of a particular kind. You might have an african stock mutual fund, a chinese stock mutual fund, a gold stock mutual fund, a chinese companies corporate mutual fund, etc. The list is long. I would however strongly discourage investing in those funds as you lack diversity and they are generally riskier. If you really have to invest, invest only a small part of you money.
If you would like to share your experience with us or to ask a question, leave a comment below.
Introduction to diversification
What is an index fund?
What is a mutual fund?
The simple rule goes like this. The riskier the mutual fund the higher the risk and the more conservative and safe it is the lower the return.
What are the types of mutual funds?
1. Equity Funds
Equity funds invest only in equities. However you may have funds that invest across the board or you may have funds that are more specialised. Some funds invest in all different types of companies and of all sizes and as a result offer some diversification. However some mutual funds invest in special sector of the economy such as green, gold or technology. Others might invest only in large, medium or small caps companies. While these funds may offer some potential for growth it is unwise to invest all your money in a fund that invest in one sector or one type of company only. If you are really interested i would suggest investing only a small amount like 5 % of your money.
I would strongly suggest investing in a fund that offer some diversification in different sectors and in different company sizes. If you are really interested invest a small part of your money in a fund like gold, green , etc that has some growth potential.
2.Bond Funds
as I have mentionned in the post on deversification and in the post on bonds, bonds offer some advantage to the investor. Bonds can bring some stability to your portfolio and bring regular income in opposition to stocks which may not give regular payment as dividends payment depend on management. A bond fund would thus invest in bonds and since bonds pays biannual coupon payment the bond will give you regular payment.
A bond fund is thus the ideal investment for a retiree for example who would have had to invest in bonds so as to be able to generate regular income. Otherwise he would have had to design a bond ladder which may be beyond the normal investor's capacity.
Like equity some mutual funds invest accross the board in a wide range of bonds of various maturity, risk and issuers. This afford some diversification and risk reduction.
However there are also a lot of mutual funds that invest in a lot of different types of bonds. some would invest only in corporate bonds, muni bonds, government bonds, junk bonds, etc. These bonds may offer some great returns but because they are specialised there is greater risk. I would advise you to invest only in a general bond fund or to invest only a small amount of money in a special fund that you like. However remember that the most fund you invest in, you increase the fees and commissions that you have to pay annually.
3. Money Market Funds
The money market is the market that deals in the trading of short term securities. That is securitie that mature in one year or less such as treasury bills, cds, etc. As you might guess such securities would offer the lowest yield but are the most secure and safe. There is no chance that you can lose your money with a money-market mutual fund. If you have some money that you cannot afford to lose but you want to earn something with it until you need it then the money-market fund is ideal for you. It gives more earning than the CDs or savings accounts.
4. Balanced Funds
The balanced mutual fund can be said to be a mixture of the equity and bond mutual fund. It provide the advantage of long term growth and gain from stocks and the possibility of regular income with bonds. I would therefore strongly reccomend this type of fund for the average investor since it provide the advantages of both stocks and bonds.
Or you could buy in one general bond fund and one general equity fund.
5. Index Funds
The index is simply an index fund that is trying to emulate another index. For example an index fund can have the same shares of all the companies in the Dow Jones. The fund will thus rise and fall in value with the Dow Jones. You can read a post here on index fund.
This is also a good way to invest. Since stocks grow in the long term an index fund will grow in value with time.
6. Speciality funds
These mutual funds invest in stocks or investment instruments of a particular kind. You might have an african stock mutual fund, a chinese stock mutual fund, a gold stock mutual fund, a chinese companies corporate mutual fund, etc. The list is long. I would however strongly discourage investing in those funds as you lack diversity and they are generally riskier. If you really have to invest, invest only a small part of you money.
If you would like to share your experience with us or to ask a question, leave a comment below.
Introduction to diversification
What is an index fund?
What is a mutual fund?
What is a mutual fund?
I think that one of the average investors' best friend is the mutual fund. So What is it and why is it that good for you?
The mutual fund is a group of investors who pool together their money and with the help of a manager buy a collection of stocks, bonds and other investment instruments. Each investors will then own a share of the collection of investment instruments.
So how do you go about investing in mutual funds? You will how to find a company that manages a mutual fund. You will then buy invest your money in the company and you will be given share in the mutual funds.
For examples if you invest $ 100 dollars in a mutual funds that has a total of $ 1000 invested. It means that you own 10 % of the mutual fund and as a result you will have a right to 10 % of the profit after expenses has been paid.
So how does the mutual fund obtain its profit?
The mutual fund get its profit in three ways:
1. The dividend on stocks, coupon payment on bonds and profit on other investments.
2. The mutual fund can sell investment that has been bought at a cheaper rate and that would result in a capital gain.
This profit is then used to pay expenses and after that the remaining profit is distributed among the members.
Another way you can get money is to buy shares from the mutual fund and then when the mutual fund's value increases you can sell the shares for a profit.
Advantages of mutual funds
Investing in a mutual funds has a lot of advantages.
1. Experience manager
The fund will be managed by a seasoned investor with a lot of experience. Most likely if you are investing in a mutual fund it means that you are inexperienced or you do not have enough time to manage your portfolio. Hence the mutual fund is good for you, the manager will invest your money for you and you just have to sit back and watch you money grow.
2. Diversification
You would remember my post on diversification. It is important that you do not invest in stocks or bonds from one company only. Investing in mutual funds will ensure that you are sufficiently diversified because the mutual fund will buy all sorts of stocks, bonds, and other instruments. Hence by investing in a mutual funds it is as if you own shares, bonds and other instruments in those companies. Hence if one company go under it would have limited effect on the mutual fund.
3. Lower cost
Because mutual funds buy investment instruments for a lot of people the cost of buying these instruments decreases considerably. If for example one person was to buy some shares by himself he would pay lets say $ 4. However if the mutual fund was to buy the shares it would also pay the same fee. It would thus mean that the cost to buy these shares will be distributed among the members of the mutual fund. This cost advantages is a definite advantage if you want to invest small amount of money and you do not want to lose a lot of your money in fees and commissions. Read this article for more details.
3. Money back easily
You would remember from bonds or stocks that it is not easy to get your money back. In the case of bonds you will have to wait for the maturity, trade it in the secondary market at a loss or pay a premium up front that will allow you to redeem you bonds before maturity. For stocks on selling the stocks you will have to pay a fee and if you have a portfolio for each type of stocks sold you will pay a fee. However for the mutual fund you just have to contact the mutual fund and you get your money back. It is as easy to get in or get out.
Disadvantages of Mutual Funds:
1. "Experienced manager"
As you can see we have the same advantage and disadvantage. Why is that? That is because a professional investor is not necessarily a good mutual fund manager. On the one hand when he is an investor he is managing his own money on the other hand when he is a mutual fund manager he is managing your money and he is paid whether there is a profit or a loss as he is only an employee. In this case it is better to invest in a mutual fund where the manager has his own money invested in the fund. It could also happens that the manager may be running a scam as the Bernie Madoff scandal showed. So shop around. I would suggest that if you want to diversify have two three different mutual fund with different companies. You could have a stock fund, a bond fund and a money market fund with three different companies. If one goes under you will not lose everything.
2. Higher Cost
Again it might mean that i am contradicting an advantage but there some mutual funds that have a lot of cost so that it would have been better if you have managed you money yourself. First of all a mutual fund is a business who has to have a profit. The mutual fund need to pay fees and commissions when buying and selling securities, postage and other administrative fees, rent, wages of employees and manager, advertising fees , etc. In some mutual funds these fees may be considerable and as a result can really reduce your earnings. So be careful when choosing your mutual fund.
3. Overdiversification
Since the mutual fund will buy into a lot of companies and a lot of bonds it may happen that you are overdiversified. If you invest in a limited number of securities it is easy to spot one that is a drag on your profit and remove it. However in a large basket of securities it is more difficult to do so and you will have some good investment that will hide some bad investment. Furthermore you may invest in a lot of companies in the same category which is not a good strategy.
So as you can see the mutual fund can be a good investment but it may have some disadvantages if you are not careful.
Please read the next post on the different types of mutual funds.
If you have some questions or want to share your experience with us, please leave a comment.
Introduction to diversification
What is an index fund?
What are the different types of mutual funds?
The mutual fund is a group of investors who pool together their money and with the help of a manager buy a collection of stocks, bonds and other investment instruments. Each investors will then own a share of the collection of investment instruments.
So how do you go about investing in mutual funds? You will how to find a company that manages a mutual fund. You will then buy invest your money in the company and you will be given share in the mutual funds.
For examples if you invest $ 100 dollars in a mutual funds that has a total of $ 1000 invested. It means that you own 10 % of the mutual fund and as a result you will have a right to 10 % of the profit after expenses has been paid.
So how does the mutual fund obtain its profit?
The mutual fund get its profit in three ways:
1. The dividend on stocks, coupon payment on bonds and profit on other investments.
2. The mutual fund can sell investment that has been bought at a cheaper rate and that would result in a capital gain.
This profit is then used to pay expenses and after that the remaining profit is distributed among the members.
Another way you can get money is to buy shares from the mutual fund and then when the mutual fund's value increases you can sell the shares for a profit.
Advantages of mutual funds
Investing in a mutual funds has a lot of advantages.
1. Experience manager
The fund will be managed by a seasoned investor with a lot of experience. Most likely if you are investing in a mutual fund it means that you are inexperienced or you do not have enough time to manage your portfolio. Hence the mutual fund is good for you, the manager will invest your money for you and you just have to sit back and watch you money grow.
2. Diversification
You would remember my post on diversification. It is important that you do not invest in stocks or bonds from one company only. Investing in mutual funds will ensure that you are sufficiently diversified because the mutual fund will buy all sorts of stocks, bonds, and other instruments. Hence by investing in a mutual funds it is as if you own shares, bonds and other instruments in those companies. Hence if one company go under it would have limited effect on the mutual fund.
3. Lower cost
Because mutual funds buy investment instruments for a lot of people the cost of buying these instruments decreases considerably. If for example one person was to buy some shares by himself he would pay lets say $ 4. However if the mutual fund was to buy the shares it would also pay the same fee. It would thus mean that the cost to buy these shares will be distributed among the members of the mutual fund. This cost advantages is a definite advantage if you want to invest small amount of money and you do not want to lose a lot of your money in fees and commissions. Read this article for more details.
3. Money back easily
You would remember from bonds or stocks that it is not easy to get your money back. In the case of bonds you will have to wait for the maturity, trade it in the secondary market at a loss or pay a premium up front that will allow you to redeem you bonds before maturity. For stocks on selling the stocks you will have to pay a fee and if you have a portfolio for each type of stocks sold you will pay a fee. However for the mutual fund you just have to contact the mutual fund and you get your money back. It is as easy to get in or get out.
Disadvantages of Mutual Funds:
1. "Experienced manager"
As you can see we have the same advantage and disadvantage. Why is that? That is because a professional investor is not necessarily a good mutual fund manager. On the one hand when he is an investor he is managing his own money on the other hand when he is a mutual fund manager he is managing your money and he is paid whether there is a profit or a loss as he is only an employee. In this case it is better to invest in a mutual fund where the manager has his own money invested in the fund. It could also happens that the manager may be running a scam as the Bernie Madoff scandal showed. So shop around. I would suggest that if you want to diversify have two three different mutual fund with different companies. You could have a stock fund, a bond fund and a money market fund with three different companies. If one goes under you will not lose everything.
2. Higher Cost
Again it might mean that i am contradicting an advantage but there some mutual funds that have a lot of cost so that it would have been better if you have managed you money yourself. First of all a mutual fund is a business who has to have a profit. The mutual fund need to pay fees and commissions when buying and selling securities, postage and other administrative fees, rent, wages of employees and manager, advertising fees , etc. In some mutual funds these fees may be considerable and as a result can really reduce your earnings. So be careful when choosing your mutual fund.
3. Overdiversification
Since the mutual fund will buy into a lot of companies and a lot of bonds it may happen that you are overdiversified. If you invest in a limited number of securities it is easy to spot one that is a drag on your profit and remove it. However in a large basket of securities it is more difficult to do so and you will have some good investment that will hide some bad investment. Furthermore you may invest in a lot of companies in the same category which is not a good strategy.
So as you can see the mutual fund can be a good investment but it may have some disadvantages if you are not careful.
Please read the next post on the different types of mutual funds.
If you have some questions or want to share your experience with us, please leave a comment.
Introduction to diversification
What is an index fund?
Wednesday, July 8, 2009
What are the different type of bonds?
The last few days I have been writing on bonds. I wrote on what a bond is and what are the differences in yield and risk associated with bonds that are issued by various entities.
There are different types of bonds. You would remember from my first post that a bond
(i) is issued at a price that may or may not be different from the face or par value,
(ii) pays coupons or interests at different times of the year,
(iii) has a maturity date and
(iv) at maturity the issuers will pay you your principal back.
However not all bonds are the same. Some bonds would have one or more of the characteristics change to either the advantage of the issuer or the bond holder. If the advantage is to the issuer the bond will be cheaper,have a higher yield or heavily discounted. If the advantage is to the bond holder the bond will be more expensive to buy, have a lower yield or issued at a premium.
Here are the different types of bonds that i know.
1. Fixed rate bond also called straight bond or plain bond.
This would be the most common type of bonds. This bond will be issued and will mature after a period of time. It will pay coupon or interest twice a year at a given rate that would remain fixed until the bond matures. The principal or the face value will be paid upon maturity along with one last coupon.
2. Zero-coupon or Accrual bond
This type of bonds would pay no coupon or interest. It would be issued at a big discount and at maturity you would get back your principal. If the bond has a par or face value of $ 100 it might be issued at $ 60. And at maturity you would be paid the sum of $ 100.
This is not good for the investor since if the issuer default you would lose everything especially if the bond has a long maturity. So better avoid this one.
This is a type of bond that makes no coupon payments but instead is issued at a considerable discount to par value. For example, let's say a zero-coupon bond with a $1,000 par value and 10 years to maturity is trading at $600; you'd be paying $600 today for a bond that will be worth $1,000 in 10 years.
3. Perpetual bond
A perpetual bond is a bond that has no maturity date. It will continue to make coupon payments from the time it is issued for ever. However there is a trick in it. It is also a callable bond. See below for what a callable bond is. It means that after a period of 5 years or depending on the stipulations of the bond the issuer can recall it at any time and give you back your principal.
However if it is not callable, then it would be similar to stocks with the exception that you will not have voting rights. However you coupon rate will be fixed compared to shareholders who are not certain to receive dividends
This is a nice bond to invest into since you have the possibility to get coupon payments for a long time. However this type of bond is rarely issued and personally I would discourage this type of bonds since it give some uncertainty in your portfolio. It is better to just invest in a long term bond or medium term bond if that is your wish.
4. Inflation-indexed bond
This is a bond that is protected against inflation. It is going to have a coupon rate that is a few percentage point above the official interest rate. This will ensure that you do not lose money in high inflationary times when the rate of inflation will be higher that the coupon rate of normal bond.
5. Convertible bond
A convertible bond is one that will give you the right to convert it into a certain number of shares of the issuing company. You would however remember from above that stocks and bonds each has its own advantages so think well before converting your bonds.
6. Reverse convertible
This bond is the reverse of the convertible bond in that it gives the issuer the right to convert the bond to cash or stocks of a company. As you may have guess this is not good for you since it gives the company more rights than you.
7. Callable bond
A callable bond gives the issuer the right to call the bonds before maturity and pay the bond holder his principal. This is not advisable for a bond holder, because if you have locked in a high coupon rate, you would not want the company to call it back and then be forced to buy a bond with a lower coupon rate.
8. Puttable bond
A puttable bond gives the bondholder the right to sell the bond back to the issuer before the maturity date. This is advisable if you are buying bonds at a low coupon rate and you are anticipating a rise in bond coupon rate.
* Inverse floaters pay a variable coupon rate that changes in direction opposite to that of short-term interest rates. An inverse floater subtracts the benchmark from a set coupon rate. For example, an inverse floater that uses LIBOR as the underlying benchmark might pay a coupon rate of a certain percentage, say 6%, minus LIBOR.
9. Exchangeable bond
Such a bond is similar to the convertible bond except that it gives the bondholder the rights to convert the bond into stocks of a particular company at a particular time in the future and in certain condition.
10. Floating rate bond
A floating rate bond is one whose coupon rate will vary with a certain index such as the rate on the 6 month treasury bill. So if you think that the 6 month treasury bill rate is going to rise you can buy a floating rate bond and linked it to the index.
11. Inverse floating rate bond
This bond will have a coupon rate that will be as in the floating rate bond above except that the coupon rate will be a number minus the index. For example you might want the coupon rate to be (10 - yield on a treasury bill )%. Hence if you are anticipating the rate on the treasury bill to fall you can buy an inverse floating rate bond linked to it.
One last piece of information. These bond flavors are not without effort. For those that comes at an advantage to the bondholder a fee must be paid with the cost price. For those that come at an advantage to the issuer a discount or an increase yield is needed.
If you have any questions or you think that i have missed one please leave a comment below.
What is a bond?
Stocks have higher return than bonds
Introduction to diversification
What is a bond ladder?
The importance of the bond issuer?
There are different types of bonds. You would remember from my first post that a bond
(i) is issued at a price that may or may not be different from the face or par value,
(ii) pays coupons or interests at different times of the year,
(iii) has a maturity date and
(iv) at maturity the issuers will pay you your principal back.
However not all bonds are the same. Some bonds would have one or more of the characteristics change to either the advantage of the issuer or the bond holder. If the advantage is to the issuer the bond will be cheaper,have a higher yield or heavily discounted. If the advantage is to the bond holder the bond will be more expensive to buy, have a lower yield or issued at a premium.
Here are the different types of bonds that i know.
1. Fixed rate bond also called straight bond or plain bond.
This would be the most common type of bonds. This bond will be issued and will mature after a period of time. It will pay coupon or interest twice a year at a given rate that would remain fixed until the bond matures. The principal or the face value will be paid upon maturity along with one last coupon.
2. Zero-coupon or Accrual bond
This type of bonds would pay no coupon or interest. It would be issued at a big discount and at maturity you would get back your principal. If the bond has a par or face value of $ 100 it might be issued at $ 60. And at maturity you would be paid the sum of $ 100.
This is not good for the investor since if the issuer default you would lose everything especially if the bond has a long maturity. So better avoid this one.
This is a type of bond that makes no coupon payments but instead is issued at a considerable discount to par value. For example, let's say a zero-coupon bond with a $1,000 par value and 10 years to maturity is trading at $600; you'd be paying $600 today for a bond that will be worth $1,000 in 10 years.
3. Perpetual bond
A perpetual bond is a bond that has no maturity date. It will continue to make coupon payments from the time it is issued for ever. However there is a trick in it. It is also a callable bond. See below for what a callable bond is. It means that after a period of 5 years or depending on the stipulations of the bond the issuer can recall it at any time and give you back your principal.
However if it is not callable, then it would be similar to stocks with the exception that you will not have voting rights. However you coupon rate will be fixed compared to shareholders who are not certain to receive dividends
This is a nice bond to invest into since you have the possibility to get coupon payments for a long time. However this type of bond is rarely issued and personally I would discourage this type of bonds since it give some uncertainty in your portfolio. It is better to just invest in a long term bond or medium term bond if that is your wish.
4. Inflation-indexed bond
This is a bond that is protected against inflation. It is going to have a coupon rate that is a few percentage point above the official interest rate. This will ensure that you do not lose money in high inflationary times when the rate of inflation will be higher that the coupon rate of normal bond.
5. Convertible bond
A convertible bond is one that will give you the right to convert it into a certain number of shares of the issuing company. You would however remember from above that stocks and bonds each has its own advantages so think well before converting your bonds.
6. Reverse convertible
This bond is the reverse of the convertible bond in that it gives the issuer the right to convert the bond to cash or stocks of a company. As you may have guess this is not good for you since it gives the company more rights than you.
7. Callable bond
A callable bond gives the issuer the right to call the bonds before maturity and pay the bond holder his principal. This is not advisable for a bond holder, because if you have locked in a high coupon rate, you would not want the company to call it back and then be forced to buy a bond with a lower coupon rate.
8. Puttable bond
A puttable bond gives the bondholder the right to sell the bond back to the issuer before the maturity date. This is advisable if you are buying bonds at a low coupon rate and you are anticipating a rise in bond coupon rate.
* Inverse floaters pay a variable coupon rate that changes in direction opposite to that of short-term interest rates. An inverse floater subtracts the benchmark from a set coupon rate. For example, an inverse floater that uses LIBOR as the underlying benchmark might pay a coupon rate of a certain percentage, say 6%, minus LIBOR.
9. Exchangeable bond
Such a bond is similar to the convertible bond except that it gives the bondholder the rights to convert the bond into stocks of a particular company at a particular time in the future and in certain condition.
10. Floating rate bond
A floating rate bond is one whose coupon rate will vary with a certain index such as the rate on the 6 month treasury bill. So if you think that the 6 month treasury bill rate is going to rise you can buy a floating rate bond and linked it to the index.
11. Inverse floating rate bond
This bond will have a coupon rate that will be as in the floating rate bond above except that the coupon rate will be a number minus the index. For example you might want the coupon rate to be (10 - yield on a treasury bill )%. Hence if you are anticipating the rate on the treasury bill to fall you can buy an inverse floating rate bond linked to it.
One last piece of information. These bond flavors are not without effort. For those that comes at an advantage to the bondholder a fee must be paid with the cost price. For those that come at an advantage to the issuer a discount or an increase yield is needed.
If you have any questions or you think that i have missed one please leave a comment below.
What is a bond?
Stocks have higher return than bonds
Introduction to diversification
What is a bond ladder?
The importance of the bond issuer?
Tuesday, July 7, 2009
What is the exchange-traded fund?
It seems that these days everybody wants to invest. The question that has to be asked is what instruments you are going to buy and why.
Because investing is a risky venture, I have often advised investors to go into mutual funds in the past. Another way is to go through the exchange-traded fund.
An exchange-traded fund is similar to a mutual fund except that it is traded in the stock exchange. Just as the mutual funds has many advantages over buying individual stocks, bonds and other investment instruments, the exchange-traded fund offer additional advantages that might interest the average investor.
You would remember that the mutual fund will buy a large portfolio of investment instruments. The net value of the mutual fund will be the market value of the all the stocks, bonds,etc of the portfolio of the fund. Thus the value of the mutual fund will increase if the value of the shares,bonds, etc increases and vice versa. However there is a problem with this. The market value of the a mutual fund portfolio is not an indication of good return. A mutual fund portfolio can be expensive but can have meager return while one that is quite cheap can have a good return.
This problem can be reduced by investing in exchange-traded fund.
What is the exchange-traded fund?
The exchange-traded fund is a mutual fund that trades on the stock exchange.Think of an exchange-traded fund as a mutual fund that trades like a stock. The company will buy a portfolio of shares and then will "go public". The company will issue stocks and these will be sold to the public. These shares of the exchange traded fund will then be traded on the stock market.
Hence the value of the exchange-traded fund will not be the total value of the portfolio like a mutual fund or the index fund. It will be the market capitalisation of all the value of the shares of the exchange-traded fund.
This is different in the fact that the value of the shares can fluctuate even if portfolio do not fluctuate. This will happen if the portfolio has a reduced learning potential. Hence the value of a mutual fund can remain constant in value while an exchange-traded fund composed of the same shares can fall in value.
So what are the advantages of investing in an exchange-traded fund?
1. Diversification
Since the exchange-traded fund invests in a wide range of stocks, then by buying the stock of an exchange-traded fund you already have the advantage of diversification. However the problem here is that if the exchange-traded fund goes down like in a sort of Madoff-like manager running away with the money, then you lose all your savings. Hence it is unwise to invest all your money in a single exchange-traded fund.
2. Advantages of a stock
Since the exchange-traded fund is traded in a stock market the everything that you can do with a stock you can do it with the exchange-traded fund. You will buy it like a stock using a stock broker and pay.fees and commissions, You can also call it, put it, etc. I would however discourage such exotic and risky style of investing.
3. Lower cost
The exchange-traded fund is usually cheaper to invest in compared to the mutual fund. That is because you need to pay only the broker commission when you buy it. Hence if you are using an online or discount broker
4. Diversity in a single stock
This might seem the same as the first one but it is a little bit different. Imagine that you have a portfolio of 15 stocks diversified in different sectors of the economy. In the traditional way of investing it is impossible to buy a lot of stocks in the same category. Imagine if you buy five stocks in each sector and you have 10 sectors of the economy then you have 50 different companies to monitor. This will be a huge task for the average investor. Also if you buy one or two in one sector and one of the companies go bankrupt then your exposure in that sector will disapppear.
The solution will be exchange-traded funds. Each exchange traded fund will specialised in one sector. For example you can have one in telecommunication that will be a basket of telco companies. If one of the companies in that sector go bankrupt then your stock will not be affected. Hence by investing in exchange-traded funds that are sector specialist instead of single stock in a sector you reduce your chance of losing your exposure to that sector.
5. Passive investment
Most exchange traded funds are passive investment
hence your return will be greater compared to a mutual fund that is actively managed. A normal mutual fund will have a lot of fees and commissions to pay as a result the profits will be less.
As you can see if you were thinking of investing then a mutual fund is good for you. Whether it is an exchange-traded fund, an index fund or a simple mutual fund the decision is yours. If you have any question leave a comment and me and my readers will try to give you an answer.
Introduction to diversification
What is an index fund?
What is a mutual fund?
The different types of mutual funds
Because investing is a risky venture, I have often advised investors to go into mutual funds in the past. Another way is to go through the exchange-traded fund.
An exchange-traded fund is similar to a mutual fund except that it is traded in the stock exchange. Just as the mutual funds has many advantages over buying individual stocks, bonds and other investment instruments, the exchange-traded fund offer additional advantages that might interest the average investor.
You would remember that the mutual fund will buy a large portfolio of investment instruments. The net value of the mutual fund will be the market value of the all the stocks, bonds,etc of the portfolio of the fund. Thus the value of the mutual fund will increase if the value of the shares,bonds, etc increases and vice versa. However there is a problem with this. The market value of the a mutual fund portfolio is not an indication of good return. A mutual fund portfolio can be expensive but can have meager return while one that is quite cheap can have a good return.
This problem can be reduced by investing in exchange-traded fund.
What is the exchange-traded fund?
The exchange-traded fund is a mutual fund that trades on the stock exchange.Think of an exchange-traded fund as a mutual fund that trades like a stock. The company will buy a portfolio of shares and then will "go public". The company will issue stocks and these will be sold to the public. These shares of the exchange traded fund will then be traded on the stock market.
Hence the value of the exchange-traded fund will not be the total value of the portfolio like a mutual fund or the index fund. It will be the market capitalisation of all the value of the shares of the exchange-traded fund.
This is different in the fact that the value of the shares can fluctuate even if portfolio do not fluctuate. This will happen if the portfolio has a reduced learning potential. Hence the value of a mutual fund can remain constant in value while an exchange-traded fund composed of the same shares can fall in value.
So what are the advantages of investing in an exchange-traded fund?
1. Diversification
Since the exchange-traded fund invests in a wide range of stocks, then by buying the stock of an exchange-traded fund you already have the advantage of diversification. However the problem here is that if the exchange-traded fund goes down like in a sort of Madoff-like manager running away with the money, then you lose all your savings. Hence it is unwise to invest all your money in a single exchange-traded fund.
2. Advantages of a stock
Since the exchange-traded fund is traded in a stock market the everything that you can do with a stock you can do it with the exchange-traded fund. You will buy it like a stock using a stock broker and pay.fees and commissions, You can also call it, put it, etc. I would however discourage such exotic and risky style of investing.
3. Lower cost
The exchange-traded fund is usually cheaper to invest in compared to the mutual fund. That is because you need to pay only the broker commission when you buy it. Hence if you are using an online or discount broker
4. Diversity in a single stock
This might seem the same as the first one but it is a little bit different. Imagine that you have a portfolio of 15 stocks diversified in different sectors of the economy. In the traditional way of investing it is impossible to buy a lot of stocks in the same category. Imagine if you buy five stocks in each sector and you have 10 sectors of the economy then you have 50 different companies to monitor. This will be a huge task for the average investor. Also if you buy one or two in one sector and one of the companies go bankrupt then your exposure in that sector will disapppear.
The solution will be exchange-traded funds. Each exchange traded fund will specialised in one sector. For example you can have one in telecommunication that will be a basket of telco companies. If one of the companies in that sector go bankrupt then your stock will not be affected. Hence by investing in exchange-traded funds that are sector specialist instead of single stock in a sector you reduce your chance of losing your exposure to that sector.
5. Passive investment
Most exchange traded funds are passive investment
hence your return will be greater compared to a mutual fund that is actively managed. A normal mutual fund will have a lot of fees and commissions to pay as a result the profits will be less.
As you can see if you were thinking of investing then a mutual fund is good for you. Whether it is an exchange-traded fund, an index fund or a simple mutual fund the decision is yours. If you have any question leave a comment and me and my readers will try to give you an answer.
Introduction to diversification
What is an index fund?
What is a mutual fund?
The different types of mutual funds
Friday, July 3, 2009
The importance of the bond issuer?
In one of my previous post i introduced the bond. You would remember that a bond is a security which is similar to an IOU. You are the lender and the entity is the borrower.
However, not all bonds are equal and some are more risky than others. Please read this post on risk and risk tolerance to familiarise yourself with the concept. Because bonds may sometime be long term investments, you need to be sure that the issuer will be solvent and has not gone bankrupt before you can get back your principal.
We are going to see below the different type of bond issuers and see which one is risky and which one is safe. But remember that the riskier the bond the greater the return. So if you are lucky and the bond issuer has not defaulted on you, it would mean that you are going to get a lot of interest or coupon payment along the way and your principal at the end.
Bond rating
Each bond has a rating associated that is provided by rating agencies. These agencies analyse the government and the company and give a rating which is simply their ability to remain solvent until the bond reach maturity. Hence a company/government with a good rating has a small chance of going into default while a poor rating means that the company/government has a good chance of going into default. The following table are the ratings that two main rating agencies associate with bonds and examples of companies.
Investment grade - Major developing countries, multinational, profit making companies,etc
Junk - Loss making companies, third world countries, etc
Generally as the bond moves from the highest investment grade to the bond grade rating, the interest rate increases. This is because the company/government issuing the bond has a greater chance of going into default and as a result you must be compensated for the risk that you are taking.
1. Government Bonds
These bonds are issued by government to finance budget deficit. This takes place when government has less tax than the money they want to spend. Generally governments obtain money by raising taxes and as a result the possibility that a government will default on its bonds is low. However with countries like Zimbabwe the possibility of default is quite high. However for most developed countries bonds are quite safe. As a result of this the interest rate on government bonds is quite low with practically no risk premium.
Even though the yield is low, it is generally advised to invest at least 10 % of your money in government bonds to minimise the risk of losing all your money in a stock market crash.
2. Municipal bonds
These bonds are the second safest behind government bonds because towns and cities can also raise taxes. However they have a lesser number of tax payers and as a result the have a higher chance of going into default. It may happen on the long run that the population of a town decreases and make the servicing of its bonds difficult. A more recent example is the towns in Michigan that are having lower population because of the demise of the car industry. Hence because the bond is a little bit more risky, the yield on it is higher. It is therefore advisable to have some municipal bonds in your portfolio. May be in the form of muni index fund.
3.Corporate bonds
The corporate bond is the most risky of all bond. The bond is the second way that a company can raise fund. One is to issue stock and the other is to issue bonds. You can read about the difference between bonds and stocks here. The reason why corporate bonds are the riskiest is because companies goes bankrupt every year. They cannot raise taxes like municipalities or governments.
As a result corporate bonds offer the highest yield. However in order to minimise risk, you need to diversify your corporate bond portfolio. Read here on diversification. Better still, if you are unable to diversify a bond portfolio by yourself invest in a corporate bond index fund.
Do you have any question on bonds or want to share your experience? Leave a comment below.
What is a bond?
Stocks have higher return than bonds
Introduction to diversification
What is a bond ladder?
However, not all bonds are equal and some are more risky than others. Please read this post on risk and risk tolerance to familiarise yourself with the concept. Because bonds may sometime be long term investments, you need to be sure that the issuer will be solvent and has not gone bankrupt before you can get back your principal.
We are going to see below the different type of bond issuers and see which one is risky and which one is safe. But remember that the riskier the bond the greater the return. So if you are lucky and the bond issuer has not defaulted on you, it would mean that you are going to get a lot of interest or coupon payment along the way and your principal at the end.
Bond rating
Each bond has a rating associated that is provided by rating agencies. These agencies analyse the government and the company and give a rating which is simply their ability to remain solvent until the bond reach maturity. Hence a company/government with a good rating has a small chance of going into default while a poor rating means that the company/government has a good chance of going into default. The following table are the ratings that two main rating agencies associate with bonds and examples of companies.
| Bond Rating | Grade | Risk | |
| Moody's | S&P/ Fitch | ||
| Aaa | AAA | Investment | Highest Quality |
| Aa | AA | Investment | High Quality |
| A | A | Investment | Strong |
| Baa | BBB | Investment | Medium Grade |
| Ba, B | BB, B | Junk | Speculative |
| Caa/Ca/C | CCC/CC/C | Junk | Highly Speculative |
| C | D | Junk | In Default |
Investment grade - Major developing countries, multinational, profit making companies,etc
Junk - Loss making companies, third world countries, etc
Generally as the bond moves from the highest investment grade to the bond grade rating, the interest rate increases. This is because the company/government issuing the bond has a greater chance of going into default and as a result you must be compensated for the risk that you are taking.
1. Government Bonds
These bonds are issued by government to finance budget deficit. This takes place when government has less tax than the money they want to spend. Generally governments obtain money by raising taxes and as a result the possibility that a government will default on its bonds is low. However with countries like Zimbabwe the possibility of default is quite high. However for most developed countries bonds are quite safe. As a result of this the interest rate on government bonds is quite low with practically no risk premium.
Even though the yield is low, it is generally advised to invest at least 10 % of your money in government bonds to minimise the risk of losing all your money in a stock market crash.
2. Municipal bonds
These bonds are the second safest behind government bonds because towns and cities can also raise taxes. However they have a lesser number of tax payers and as a result the have a higher chance of going into default. It may happen on the long run that the population of a town decreases and make the servicing of its bonds difficult. A more recent example is the towns in Michigan that are having lower population because of the demise of the car industry. Hence because the bond is a little bit more risky, the yield on it is higher. It is therefore advisable to have some municipal bonds in your portfolio. May be in the form of muni index fund.
3.Corporate bonds
The corporate bond is the most risky of all bond. The bond is the second way that a company can raise fund. One is to issue stock and the other is to issue bonds. You can read about the difference between bonds and stocks here. The reason why corporate bonds are the riskiest is because companies goes bankrupt every year. They cannot raise taxes like municipalities or governments.
As a result corporate bonds offer the highest yield. However in order to minimise risk, you need to diversify your corporate bond portfolio. Read here on diversification. Better still, if you are unable to diversify a bond portfolio by yourself invest in a corporate bond index fund.
Do you have any question on bonds or want to share your experience? Leave a comment below.
What is a bond?
Stocks have higher return than bonds
Introduction to diversification
What is a bond ladder?
Wednesday, July 1, 2009
How to buy and sell stocks using a broker?
In my two previous post here and here I wrote about what a broker is and how to go about to have a brokerage account.
If you have a full-service broker chances are that you will not need to know these information as the broker will do every thing for you. However it is wise to learn so that you can become more knowledgeable about investing.
If you are have a discount broker then you need to tell him what you want him to do. To be able to do this properly you need to know certain terms so that he will do what you want. You will then communicate this to him by phone or by any previously agreed means in your agreement or brokerage contract.
Here is how things goes. On the market there are people who want to sell stocks and other securities and those who want to buy.
Let say that three people want to sell stock of company x at the following prices. These are the sell prices or the ask prices.
Person A $50
Person B $51
Person C $52
Now three people want to buy the same stock at the following prices. These are the bid prices.
Person D $48
Person E $47
Person F $46
Note that those that are selling are always offering a higher price than those who are buying. The difference between the two is called the ask-bid spread.
In our example the ask-bid spread is $2. This information means that the buyer will have to raise his bid price by two dollars to be able to buy his security or the seller has to lower his ask price by two dollars to be able to sell his security.
What is important is that the person who is ask the lowest price will be given priority and his stocks will be sold first. The same is for those who want to buy stocks, the person who bid the highest will be given stocks in priority.
However if there is a deadlock and that no stock is changing hands, the the seller can suggest the highest bidding price and his stocks will be sold. Using the example above if person A decreases his ask price to $48 then his stocks will be sold to person D. The opposite is also true. Person D can increase his bid price to $ 5o dollars as a result he will be able to get the stocks that person A is selling.
Now what orders are you going to give the broker?
1. Market Order: The broker will buy the stocks at the best available price. In this case if you are person D you will be giving the broker the instruction to buy shares at $50. This order will be executed immediately.
Limit Order: This will be for the broker to buy only when stocks are available at a given price or to sell only when there are buyers that are prepare to buy stocks at the price that you want.
Stop Order: This would mean that you are giving your instruction to stop buying once stocks are exceeding a level and are being too expensive to buy. This is called a stop-limit. You can also give a broker an instruction to sell your stocks once the value of the stock fall below a certain level. This may be because the stock has been bought at a higher price and that the lower it falls the more loss you are going to make on it. That is why such an order is called a stop-loss.
All or None (AON): This means only to buy stocks if all your order can be fulfilled. Sometime if you want to buy 500 stocks of company x at $50 and that there is a seller of 400 stocks at $50, normally the broker will buy the 400 stocks for you. In the All or none the order will be executed only if there is a seller of 500 stocks.
Day Order: This order will be only for the day. That is because some order can continue until the condition for the order is satisfied.
Good Till Canceled (GTC): This order will remain valid unless it is executed by the broker or cancel by the person.
Fill-Or-Kill: If this order is not executed immediately then it is to be canceled.
This now end the three part series on the broker and the service that they offer.
Do you have any question or you want to talk about you experience on using a broker? Leave a comment below.
If you have a full-service broker chances are that you will not need to know these information as the broker will do every thing for you. However it is wise to learn so that you can become more knowledgeable about investing.
If you are have a discount broker then you need to tell him what you want him to do. To be able to do this properly you need to know certain terms so that he will do what you want. You will then communicate this to him by phone or by any previously agreed means in your agreement or brokerage contract.
Here is how things goes. On the market there are people who want to sell stocks and other securities and those who want to buy.
Let say that three people want to sell stock of company x at the following prices. These are the sell prices or the ask prices.
Person A $50
Person B $51
Person C $52
Now three people want to buy the same stock at the following prices. These are the bid prices.
Person D $48
Person E $47
Person F $46
Note that those that are selling are always offering a higher price than those who are buying. The difference between the two is called the ask-bid spread.
In our example the ask-bid spread is $2. This information means that the buyer will have to raise his bid price by two dollars to be able to buy his security or the seller has to lower his ask price by two dollars to be able to sell his security.
What is important is that the person who is ask the lowest price will be given priority and his stocks will be sold first. The same is for those who want to buy stocks, the person who bid the highest will be given stocks in priority.
However if there is a deadlock and that no stock is changing hands, the the seller can suggest the highest bidding price and his stocks will be sold. Using the example above if person A decreases his ask price to $48 then his stocks will be sold to person D. The opposite is also true. Person D can increase his bid price to $ 5o dollars as a result he will be able to get the stocks that person A is selling.
Now what orders are you going to give the broker?
1. Market Order: The broker will buy the stocks at the best available price. In this case if you are person D you will be giving the broker the instruction to buy shares at $50. This order will be executed immediately.
Limit Order: This will be for the broker to buy only when stocks are available at a given price or to sell only when there are buyers that are prepare to buy stocks at the price that you want.
Stop Order: This would mean that you are giving your instruction to stop buying once stocks are exceeding a level and are being too expensive to buy. This is called a stop-limit. You can also give a broker an instruction to sell your stocks once the value of the stock fall below a certain level. This may be because the stock has been bought at a higher price and that the lower it falls the more loss you are going to make on it. That is why such an order is called a stop-loss.
All or None (AON): This means only to buy stocks if all your order can be fulfilled. Sometime if you want to buy 500 stocks of company x at $50 and that there is a seller of 400 stocks at $50, normally the broker will buy the 400 stocks for you. In the All or none the order will be executed only if there is a seller of 500 stocks.
Day Order: This order will be only for the day. That is because some order can continue until the condition for the order is satisfied.
Good Till Canceled (GTC): This order will remain valid unless it is executed by the broker or cancel by the person.
Fill-Or-Kill: If this order is not executed immediately then it is to be canceled.
This now end the three part series on the broker and the service that they offer.
Do you have any question or you want to talk about you experience on using a broker? Leave a comment below.
How to start investing with a small amount of money?
Fees and commissions and how they affect your portfolio.
How to choose a broker?
What is a stock?
Stocks have higher return than bonds
How to be rich buying stocks!!
Should i sell my stock and hold cash?
Introduction to diversification
How and when dividends are paid?
what is a stock exchange?
How to choose a broker - part 2?
How to choose a broker - part 2?
In the first post that you can read here, I talked about the different types of broker and what type of broker would be appropriate for your situation.
Today I will tell you about how to go about creating a brokerage account.
At this point you have analyzed your situation according to the first post and have decided whether you want a discount broker or a full service broker. You have most probably chosen a broker according to the factors mentioned in part one.
How to set up the account?
When setting a new brokerage account it is important to follow the following steps.
1. The broker should understand clearly what your objectives are. You may simply want him to execute your orders as you will do all the thinking or research. However you may want him to do more than that. You may have some long term objectives such as retirement, your children studies, etc. These objectives should be clear to him as he will devise an investment plan for you that will enable you to attain these objectives.
2. The broker should understand what is the level of risk that you can bear. That is your risk tolerance. Read this post to understand and determine your risk tolerance. The broker should know this so that he can recommend the type of securities that fit the level of risk that you can bear.
3. The broker should know your complete financial situation.He should know your income so that he and you can determine the amount of money that you can invest monthly so that you can reach your objectives. However this may help him determine whether investing is appropriate for you. Remember if you have any debt, investing may be inappropriate for you. Read this post on the subject.
4. The power of the broker. If you are unable to make proper assessment of securities, then it is appropriate to let the broker assess the securities and then take the decisions for you. But this right should be in written form, and any decision should be such that it goes toward reaching your goals. A decision by the broker should never be such that it is against your interest or towards reaching your aim.
5. Every time you buy and a security it must be in the prescribed form that is recommended in the contract. If the contract states that orders to be in writing then only written orders will be accepted to buy or sell securities. Also every time a securities is bought or sold you must have written confirmation of it.
If trading is done electronically then you will not have a certificate but simply a notice. If trading is not electronically then the broker can send you the certificate or keep it at the brokerage firm if that is in your contract or agreement.
6. Make sure that everything that we have talked above is in writing and that you have a copy of the contract. You should keep a copy of this for future reference. Everything that the broker can do should be according to this contract.
Now that you have a broker learn how to buy stocks here.
Do you have any questions on choosing a broker? Do you want to share your experience with us?Please leave a comment.
How to start investing with a small amount of money?
Fees and commissions and how they affect your portfolio.
What is a stock?
How to be rich buying stocks!!
How and when dividends are paid?
what is a stock exchange?
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