What are the advantages of holding bonds?

We have seen in this post what bonds are. However have you asked yourself what are the advantages of holding bonds. We are going to have a look at the different uses of bonds for the average investor.

1. Safety investment

One of the most important uses of bonds for the average investor especially in this recession is to secure your portfolio. Investors who anticipates a bear market, turmoil in the stock market or a recession  might not want or have the courage to watch their portfolio’s value fluctuate widely. As a result in anticipation they will want to sell their investment and flee to the safest investment. Some will invest in treasury bonds, treasury bills, high quality corporate bond or money market mutual funds. After the events the investors can sell these safe assets and then reconstitute their portfolio. 

2. To maintain the value of the portfolio

The first use of bonds for the average investor is to maintain the value of the portfolio. Most bonds can be said to be quite safe especially if you invest in government bonds and investment grade corporate bonds. Because bonds are issued at a discount and then redeemed at face value the investor is certain that he will obtain more than he invested initially. Furthermore some bonds will pay coupons twice a year. So even if the return on bonds are small, the investor is assured to end up with more that he started with. If you invest in treasury inflation protected securities then your principal will be adjusted so that you will not be hurt by inflation. thus your return will always be greater than inflation.

3. Diversification

Diversification a strategy whereby you invest in a range of securities and in various sectors so that they will not be affected equally. If your portfolio is equally diversified it is possible that some of them will increase in value while while some of them will decrease in value thereby offsetting each other. Bonds are the best asset to hedge against stocks. As you the value of stocks increases and decreases while that of bonds will remain the same. Hence when the stock market is down the presence of bonds will reduces the loss of value of the portfolio. Now when the stock market is up the percentage of stocks in the portfolio increases as a result to keep the value of bonds in the portfolio constant you will have to rebalance. You will thus sell stocks to buy bonds. This will ensure that you lock the gain in stock market by buying bonds.

4. Fixed income generation

Some people, especially retirees need a regular source of income. Because bonds pay regular coupon every six months a portfolio that has a sufficient number of bonds in it will provide income to the retiree on a regular basis. Stocks on the other hand pay dividends but it is not compulsory for companies to pay dividends so an investors that have stocks in his portfolio is not certain of receiving dividends on a regular basis. However since on the long run the stock market rises then the investor is sure that the value of his stocks will increase with time.

As you can see it is very important to have a certain percentage of you money invested in bonds for the presence of bonds will help to stabilise your portfolio. 20 % for the aggressive investor up to 40 % for the prudent investor is an appropriate allocation. However make sure that your bonds are sufficiently diversified ranging from safe government bonds to slightly yieldy corporate bonds. If you are adventurous you can invest in municipal bonds.

What is a Banker’s Acceptance?

As we have seen in an earlier post, the Banker’s Acceptance is one of the instruments traded in the money market.

It is simply an instruments that are used by companies to obtain funds. It is generally cheaper than loans or overdraft.

Let us take the examples below to understand how it works.

A company needs money to buy goods for the Christmas season and want to obtain funds from the bank and will pay back the money after Christmas. This company generally needs to pay cash especially if it is buying goods abroad where companies do not want to take the risk to give goods on credit.

The company will approach his bank and will enter into an agreement according to the sequence below.

1. The company approach the bank to enquire about the discount rate on BAs.

2. The BA will have a face value that the company will have to pay after a specific period of time. Likewise any investor that have bought the BA on the secondary market and who will present the BA to the bank at maturity will receive the face value as indicated on the BA.

The BA will also contain the commission that the bank will take from the company. Hence the bank will pay the company the face value minus the commission. If the face value is $ 1 million and the commission of the bank is $ 20000 then the company will receive only $ 980 000. 

3. If the bank accepts this agreement it will endorse it. Hence the name of Banker’s Acceptance. If the bank has accepted the agreement it would have to pay the face value of the BA to the holder of the BA at maturity.

4. The bank will then sell the BA on the secondary market where it will be traded until it reaches maturity.

5. At maturity the company will pay back the face value of the BA to the bank. However even if this does not happen, the bank will have to pay the holder the face value.

However I would still discourage small investors from investing directly in the money market. It is much better to invest in a  money market mutual fund.

What are treasury bills?

Treasury bills is one type of instruments that is traded in the money market. 

A treasury bill is typically a bond that is issued by a central bank or by a government that has a maturity of less that one year. The treasury bill is sold without coupon payment. A coupon is a payment that is made every six month. It is paid as a percentage of the nominal price of the bond.Hence the treasury bill is sold at a discount and then the government will pay the face value at maturity.

These treasury bills are issued by governments in order to raise funds from the market. Because these bonds are issued by the government of a country it is therefore considered to be the safest asset and as a result would have the lowest return of all. Because of its safety it is used very often to calculate the bond spread of other bonds. The bond spread is simply the difference in return between the other bond and the return on a three month treasury bill. The greater the bond spread the riskier the bonds.

Treasury bills are also the most liquid and the most traded of all instruments. This is mainly because banks and other non-bank financial companies are required by law to hold them. For banks they may be used as collaterals in repo transactions with the central banks or in the interbank market to obtain funds. Because they are highly liquid these institutions hold them so that they can be readily converted to cash to settle obligations. Otherwise if they have excess funds they invest them in treasury bill in order to get a decent return. Short term insurers also hold a significant amount of treasury bills because they also need to have access to their fund on short notice.

These treasury bills are issued in two ways. They are either issued through auctions or over the counter. Banks and other institutions participate in weekly auctions. They state the price, the discount rate and the maturity that they want and the central banks will allocate the bills starting from the one offering the highest offered price. After they are issued in the primary market they can then be sold in the secondary market where you can buy them. However you can still buy them directly from the central bank.

As an investor you might obtain treasury bills at any institutions that have them in their portfolio and are prepared to sell them or over the counter at the central bank. But I would strongly advise investing in a money market fund if you want to gain exposure to the money market.

However since treasury bills are the safest of all investment it makes no sense investing a lot of money in them. At best you can invest 5 to 10 % in them in case you want to diversify your portfolio and decrease the riskiness of your portfolio. I would myself advise about 10% in a money market mutual fund, 10% in a bond mutual fund and the rest in other instruments such as gold, stocks, and so on.    

What is a penny stock?

As the name suggest a penny stock that is worth pennies or is quite cheap. The definition varies but any stocks that is very cheap compared to price of solid companies may be considered as a penny stock. That compared to stocks like Microsoft that may worth hundreds of dollars. Since a stock’s price is a reflection of the future earnings of the company then in theory a penny stock is the stock of a company whose earning’s prospect is quite tiny to be respectful.

So what is the fuss you may ask. The penny stocks is composed of two types:

1. The first group of stocks is made up of the stocks of companies that that are going out of business. Think of a company of  camera with reels, a magnetic tape company, or a company that makes floppy disks, etc. These companies may once have been mighty, but their products are now obsolete or their business model have failed and as a result they will certainly go out of business unless they reform or restructure. So any stocks of these companies is throwing money out of the window.

2. The second groups consist of tiny companies that have just started up but do not have the recognition of the bankers. So they are craving for you to give them the chance  that they need. Think of Microsoft or apple in the 70s.However you also know that 90% of small businesses will go out of business in the next 2 years. So it is still quite difficult to spot the company that will make it big.

Now that you have understood what penny stock is you can see that it is quite risky to invest in them but if you are able to spot the one then you can multiply you money by a lot.

 

Let us look at the factors that makes these stocks risky.

1. These stocks are generally not listed on an exchange. This may be because to list on an exchange a company have to abide to some strict conditions such as financial reporting guidelines, directors have to abide to some rules, etc. If these companies cannot abide to these rules that are there to protect shareholders or other stakeholders, then it is not a good idea to invest in them. Financial statements will enable you to analyse the company’s performance other several years and see if they are worthy of your money. The companies may be run by convicted directors. Companies run by convicted companies will not be allowed to list on exchanges and if they are not listed on exchanges they will not provide reports and as a result you will not know about the directors. As you can see there are a lot of risks.

2.If you have bought these stocks then someone out there may be thanking all the gods of the earth. You do not get an idiot everyday to buy a stocks that no one want. This is because penny stocks are illiquid that is they are difficult to sell. There are a lot of sellers but a few buyers. The only way people can sell their penny stocks is only if someone is foolish enough to buy it.

3. These stocks are easily manipulated by fraudsters. Since they are illiquid and hard to sell, some people buy them cheaply and then make a hype about the stock so that unsuspecting buyers will but them at a higher price.

As you can see it is quite risky to buy these types of stocks. Although you would make it big if you can buy in the next apple or the next Microsoft it is more likely that you will lose your money. So just like I advise investors to avoid derivatives, I would advise them to avoid penny stocks. Invest in healthy companies. Also if a listed companies is delisted or is about to delisted get out immediately.

Good luck to you all in your investing.

Strategies of the successful investor part 3:Do not follow the herd

If there is one thing that I have learned during this 2008-2009 recession is that following the herd is pointless and a waste of time. Hence while everyone was selling in the stock market and buying in the money market, I have been buying stocks on the cheap. the same thing goes for the bond market.

The reason for this is an old instinct from when humans were still like animals, the crowd effect or the herd effect. This instinct meant that when you see a whole bunch of people running in a certain direction, then it must mean that they are running away from a danger and as a result you must run with them.

So how does this translate in the investing world? If you see a lot of investors buying or selling a particular stocks then it must mean that they are right and as a result you must buy that stock too. The second reason is that as people buy that particular stock its value increases and the gain or return on investment increases. As the gain increases those that have not yet bought the stock would be pressured to buy the stock either by the investors that they work for or by their employers. This is a vicious cycle that few could resist.

Guest what I have done it and you can do it also.  How so you would ask.

First of all the only way you could make money on such bull market is to buy it first when it is cheap and then selling to the herd followers when has risen to a high enough value. I would say that this is difficult to do. If you have seen it the surely a lot of people would have seen it. However if you have been able to see it early and get on the bandwagon just wait until it is high enough and wait for some time and sell it so someone else. Do not wait for the top of the ride because when people realised it is all bullsh_t then they would be selling and you would not be able to get your money back.

Apart from such herd following tactics I have my own way of buying stocks. Research is important and as a result you must educate yourself in economics and some basic accounting. Certainly you can watch TV or read newspapers but only to get information on the economy and on spotting trends in the economy that you can exploit by investing in companies that are in that sector.

When you have learned some basic knowledge you can use that knowledge to research companies. You would analyse their financial statements, their future probability and the market they are in. For example you could see that KodaK and their future in the photo reel market is a dead end as they are entering the digital photography market fast enough.

If you want to go into mutual funds, index funds and Exchange traded fund then you could use your knowledge to research the different companies that are offering them. You would make research on historical return, management, commissions and fees and so on.

Very often you would come across the internet websites that promises to teach you how to invest and as a result you would obtain great return. Most of the time you would have to buy a report or a document that promises to give you tips on how to invest and as a result you will make great return. Most of these are false promises and a complete waste of money. Imagine if you have discovered a stocks that promises great return, would you make it public? Certainly not! you would secretly buy it little by little so as not to arouse suspicion. You would keep it a secret and earn the return alone. That is why you should keep to your plan and not buy all the crap documents that are being sold on the internet.

Sure I read on the internet but only information websites like the BBC, Yahoo money or famous economics like Paul Krugman. These website will give analysis on the economy as a whole and will give you indications on what the economy is going to do.

The last advise that i would give is to make your own research and follow your investment plan. Never never follow the crowd. Stick to your investment plan and to you asset allocation and you would stay on tract to meet your objectives.

Strategies of the successful investor Part 1: Set up a plan

This is the first part of a series of post which would be about the strategies of the successful investor. As we have previously discussed the only way to be secured financially is through investing. However there are some very important things the the beginner investor must keep in mind so that his portfolio will grow with time.

A plan is the cornerstone of your investing journey. The plan is simply a document that would guide you and make sure that you do not get off-track.

It contains firstly your objectives.Each person may have different objectives and to state them clearly and the time available is crucial to your plan. You may want to retire in 35 years or to send your child to college.

After having written your objectives you would thus try to determine the amount of money that would be required to achieve these objectives.

After having identified your objectives and the money that would be needed, you would then be able to identify the return that would be required to reach that amount of money. Your portfolio will thus have to have a certain annual return so that you will be able to reach that objectives. If you cannot reach that return then you would be unable to achieve your objectives.

However the return is also related to another term and that is your risk tolerance. This is related to the different component of your portfolio and the return of your portfolio. You have to understand that some investment instruments are risky in that you can lose your money especially if the company go bankrupt but if you can hold on to it and the company stays afloat you would have greater return. The higher the riskiness and the greater the return. Some people have a low tolerance and as a result would want safe assets. However safe assets would result in low return. Hence if you want higher return you would have to invest in riskier assets.

After having chosen the return that you want and the risk that you are prepared to tolerate you would thus be able to choose the investment instruments that you need to invest in to achieve the return that you want. 

What is a money market?

The money market is one of the markets that companies and government used to raise funds. What is special about the money market is that securities with a maturity of less that one year are traded in it.

In general all of the money market are debt instruments issued government, banks and companies. These instrument are very liquid and quite safe. As a result because of this safety they have a relatively low return. You would understand that generally instruments that are quite risky have higher yield and vice versa.

The following are the different money market instruments that you can invest in:

1. Treasury bills
2. Banker’s acceptance 
3. Negotiable certificate of deposits
4. repos and reverse repos
5. Commercial papers
6. Eurodollars

However compared to the stock market whereby individual investors can buy individual stocks, money market instruments are issued in high denominations and as a result it is quite difficult for individual investors to but them. The only way for investors to invest in them is through mutual funds and exchange traded funds. However if you have a lot of money you can buy treasury bills from the reserve bank offices.

These money market instruments are like instruments in the bond market in that they are not traded in a stock exchange like shares but are traded over the counter.

There are various reasons for an investor, a bank or an institution to buy securities in the money market and they are as follows:

1. The securities in the money market are very secure and as a result investors that have some money for a short period that they cannot lose prefer to invest in the money market and get a small return until they need the money. They can when needed sell the securities easily to get their money back since money market securities are highly liquid.
2. Some banks are obliged by law to hold a certain amount of money market securities to use as collateral in repo transaction with the central bank. These banks must also have assets that they can easily convert to cash in case money is needed to satisfy liabilities. Since these money market securities are highly liquid they are easily sold in the secondary market.
3. Some type of financial market institutions like short term insurer need by law to hold a certain amount of highly liquid money market instrument so that they can   meet their liabilities.
4. Some investors are risk averse and as a result they have a low risk tolerance. These investors prefer to forgo the high return associated with stocks and prefer to hold safe money market securities that however have low return.
5. Investors and financial institutions that have excess cash, for example after selling stocks and bonds that are falling in value or are about to default and are waiting to invest in other securities, can invest in money market securities and have a small return instead of holding cash with no return.

There are also many other reasons for investing in the money market and as time go by I would increase and refine the list above. So if any of the reasons is appropriate to you then go ahead.

However keep in mind that in the long run investing in the money market is not advised as the return is low. However there is a type of investing strategies called the permanent portfolio that relies on investing in the money market. I would write on it in another post.

Risk and return

One of the most important concept in investing is the concept of risk and return. The lower the risk the lower the potential for the return and conversely the higher the risk the greater the potential of return. In order to be a successful investor you should be able to assess what is your risk tolerance and what is the level of risk in your portfolio. Finally you should be able to decide what is the level of risk that goes with your risk tolerance.

Riskiness of investment

Investments can classified in term of risk. Some investments are quite safe and as a result the possibility if losing your capital is low. Others are riskier because the possibility of losing your capital increases and as a result the person in need of the capital will have to compensate you for taking the risk and hence you will obtain the higher return. Probably the person that raised the capital is doing an activity that has a chance of failing.

The table below shows the different investment instruments in term of the risk associated with them.

As you see, the different instruments can be classified in three different categories depending on the level of risk associated with them and the potential for return.

Group one investment instruments are relatively safe and as a result there is little possibility of losing your capital. Even though on rare occasions relatively safe companies and banks can go bankrupt and make you lose the money in your bank account or the capital of your bonds.

Group two investment instruments are moderately safe and as such give average return. Their is always the possibility of a company going bust or than a town or a state will default on payment. For example if you hed stocks in Leyman Brothers your share will have no value as of now. Also states like California may default on payment of bonds in the future if the deadlock on budget expenditure is not resolved.

Group three investment instruments are highly risky and speculative. There is a great possibility that you will make great return or great losses. You can have bonds from Iceland for example that are highly speculative and you can lose your capital if you invest in these but if the country can hold until the bond reaches maturity, the interest earned will be high and you will get your capital back.


Risk Tolerance

Before jumping in with your hard-earned money and starting to buy investment instruments you need to determine your risk tolerance. The risk tolerance is simply how much risky investment you can hold in your portfolio and you are comfortable with. After you have determined your risk tolerance you will then be able to determine the type of investment instruments you will be able to buy.


Three factors will affect your risk tolerance.

Time

When you invest, you will need to determine your goals. And the time left to attain these goals. If the time left is long then you can afford to take more risk because should you suffer a loss you will have time to recover the loss. You will invest heavily in stocks, company bonds, real estates, etc. You will be an aggressive investor.

However if the time left is short, then you would want to invest in safe instruments. You will not want to risk losing in your money. May be your son will go to university next year, or you will retire in the next ten years. These people will probably shift out of shares and company stocks and invest in safe instruments such as CDs, government bonds and debentures, blue chip stocks or bonds. You will be a conservative investor.

Acceptance of loss


Some people even though they know that they have a long term investment plan, they are not satisfied to the idea that in the short term their investments can decrease in value but keep on increasing in value over the long run. These people will thus choose to be conservative investors. They will contend themselves with measely and mediocre return.

If you want to know how to allocate your portfolio read this post.

You will probably want to read this post on diversification.

What is market capitalisation?

There are two terms that define the value of the company.

1. The asset value
2, The market capitalisation

The asset value

The asset value is typically the total commercial value of all the buildings, equipment, furniture, patents , etc of the company. Typically everything that can be sold for a price. The reason that asset price is not used is that investors prefer to use market capitalisation as it is a better estimate of the company's ability to make a profit. A lot of asset is not an indication of the ability to make profit.

The market capitalisation

The market capitalisation can be calculated using a simple formula

Market capitalisation = share price X number of oustanding shares

Companies are classified in six broad categories depending on their market capitalisation.

Mega cap

A mega cap company is one that has a market capitalisation greater that $200 billion dollars. These companies are generally large and profitable such as Exxon. There are few of them. Generally their shares are quite expensive and difficult to obtain. If you have them in your portfolio keep hold of them.

Large cap

A large cap is a large company with a market capitalisation of $ 10 billion to $ 200 billion. Examples are Microsoft and IBM. These companies are relatively safe to invest but just as the mega cap their shares are relatively expensive and difficult to get. If you have them keep them unless a major catastrophe will befell the company.


Mega caps and large caps are also called blue chip companies. They are relatively secure to invest in. If you can get your hands on them in this bear market buy them and keep them. You will hold them for the long term.

Mid cap
A mid cap company has a market capitalisation of between $2 billion to $ 10 billion. However these companies offer greater return to the investor but a few of them will certainly fail. This make them a risky bet for the investor so it is better to limit your exposure to mid cap to not more that 20 %.

Small cap

A small cap company is relatively young and has a market capitalisation of between $ 300 million to $ 2 billion. Such a company offer great opportunity for growth. Imagine that if you invested in microsoft when it was a small cap you would be rich today. However a lot of small cap

Smaller companies are called micro caps and nano caps. They are very risky and if you want to invest in them you have to be very careful and limit your exposure to them to just a few percentage points of your wealth.

One last piece of information is that this information is not valid for every country. It is made for multinational companies. If you want to have your own classification for say Egypt, you will have to take the biggest company by market capitalisation and called it a mega cap and classify the other companies according to their market capitalisation.


Good luck. As usual i would like to give this advise again. As a new investor you should limit your exposure to small caps and mid caps. Only after having gained some experience and being able to analyse companies can you increase your exposure to them.

Happy investing.

Fees and commissions and how they affect your portfolio.

One of the things that you do not hear often is the impact of fees and commissions on your portfolio. Their is a good reason for this. The financial system has no advantage in whether your portfolio grow and shrink. That is because they derive their incomes from fees and commissions.


When you start investing you need to know that whenever you do a transaction you will need to pay a commission. When you buy or sell a share or any investment instrument you pay a commission. You might not realize it but if you start with a small sum you will soon find that you will have paid a large part of it to the brokerage firm as commissions.

To understand what it meant to your portfolio. Lets assume that you invest 1000 dollars with a fee of 10 dollars per transactions. You buy five types of shares. The fees is now 50 dollars. This is 5% of the investment. So if your portfolio has a rate of return of 5% per year then it meant that you will have to wait more that one year just to break even. So imagine that you start to buy and sell shares very soon your portfolio will start to shrink at a rate of 5 dollars per transaction. As you can see it is not a viable option for the new investment to trade often. That is the reason that I favour the buy and hold strategy, at least in the first few years.

So what to do?

When it come to fees the different instruments are not equal to each other. So here is an analysis of different instruments and how they differ when it come to fees.

1. Bonds, gilts and treasury bills.

These can be available at any central bank or their regional offices. They come with little fees.
However their return is not that mush.

2. Exchange traded funds, mutual funds and index funds.

These are my favorite when it come to reduce fees and commissions. It is ideal for the beginner investor. In fact it reduces the impact of diversification which is a great fee and commission eater. I think that a beginner should stick with these funds until they can understand the market and trade on their own in stocks.

3. Stocks

Stocks is the investment instruments that has the highest fees and commissions. In order to have a good portfolio an investor will have buy into many stocks and that will make the initial commision payable high. So i would advise any new investor to stick to bonds, cds, and funds.

4. CD, Certificate of Deposits

These come with small fees and some banks do not charge any. But Beware most banks do have a penalty when to come to taking your moner before the maturity date.

As you can see the fees and commisssions should be kept in mind if you a new investor. If you are not careful the only person that will benefit is the broker.

What is inflation and how does it affects your portfolio?

One of your most deadly enemy is certainly inflation. While the aim of your portfolio is to grow with time your first aim is to make sure that your portfolio is able to keep up with inflation.

So what is inflation and why is it so deadly?

Inflation can be defined as the increase in the price of goods, services, wages and natural resources. Simply speaking the price of everything that a person may want to buy increases with time as a result his salary will also tend to increase just to be able to buy the same amount of goods.

What are the effects of inflation on investors?

1. It decreases the real value or purchasing power of actual money. If the price of goods increases with time, then a sum of money will buy less and less volume of goods with time. As a result you will have to work hard to increase the value of your investments just to keep the volume of goods that you can buy constant. One of the first aim of any investors in is thus to be able to beat inflation. If you are unable to beat inflation then the real value of your portfolio , measured in the volume of goods that you can buy , will decrease with time.

2. It cause severe disruption to stock markets for investors will tend to buy stocks that give a return greater than the rate of inflation. Any stocks that is unable to beat inflation will be sold even though the company may be of sound health but is just suffering from a temporary setback. It just amplifies the sell off of stocks that is giving low return irrespective of sound fundamentals.

3. Bond that has medium and long term maturity and that has not been indexed to inflation will slowly lose value if inflation is greater than the interest rate on these bonds. People who have invested largely in bonds will thus sees their portfolio decrease in value with time.


4. Some stocks do badly in an inflationary environment. This is because increase in the price of raw materials is more difficult to pass to consumers in a competitive market. As a result this will drive the profit margin down. This will have a two fold effect on these companies. (a) it will make it difficult to give wage increases and (b) if wage increases are given then the dividends given to shareholders will drop causing a drop in the share prices of these companies.

As you can see the effects on investors and companies alike can be quite devastating. Even moderate inflation if compounded over a long time can be quite dangerous.

So what can be done to reduce the effects of inflation?

The best way to fight inflation is to be well invested with the long term in mind.
Although inflation decimate all investment categories over the medium term, the return over the long term tend to be greater than the cumulative effect of inflation. Also inflation do not affect all asset categories to the same extent.

A well diversified portfolio with the following asset class will make your portfolio inflation resistant.

1. Treasury bills and bonds
Although treasury bills and bonds suffer poorly in inflationary periods, they are able to maintain the value of the portfolio in time of stock market crash and deflation. Also even bills and bonds over the medium and long term have returns that exceed inflation.

2. Stocks
Stocks suffers less that treasury bills and bonds they have the highest possible return when considered over the long term. As a result a well diversified stock portfolio with stocks from different industries and different countries will resist well again inflation. Since inflation does not affect every country and industry the same way and at the same time.

3. Gold

Gold is a good inflation hedge. In inflationary times the value of gold rises to keep up with inflation. So it is a good advise to have a certain percentage of your wealth in gold. Beware however that gold only keep its value and offer no return.Hence your investment in gold will not increase in real value but merely keep up its value.

4. Commodities

It is known that the value of commodities increases in time of inflation, although some commodities will not behave this way. So if you are of the adventuring type, you can invest in commodities futures. I would however not advise any one to do so.

5. Real estates

It is well known that land is a good investment and that it behaves like gold and will keep up the value of the portfolio especially in trouble times. I would thus give the same advice as with gold as land offers no return.

Ok guys that is all. As you can see a well diversified portfolio is a good inflation strategy as over the long term its return will be greater that inflation.

Happy investing.

How to survive in the downturn?

In each downturn in the market the portfolio of each investor is tested and some passed the test with some degree of success while others fail. So what do those portfolio have in return and what step can you take to make sure that your portfolio resist the downturn. If you however failed to hold your portfolio together, the lessons learned in this recession will be for a lifetime.

Step 1. Diversification
Your portfolio should be well diversified with a balanced mix of all types of assets.The different types of assets will ensure that while some may decrease in value, the others may hold their value or even appreciate. In this recession some investments that were initially expensive will now become cheap and as a result you will be able to strengthen your portfolio by diversifying further.

You should have in your portfolio a considerable share of defensive counter-cyclical stocks, gold and precious metals, real estates and bonds. These will ensure that your portfolio do not lose value too much in case of a stock market crash.

In such a downturn, even the safest of investments can go bad. So diversification is even more important.

Step 2: Hedging
Hedging is even more important when you consider investing in a recession. I do not mean the type of hedging by hedge funds. I mean that every risk that an investment can have should be offset by another investment. For example if you buy a bond in a risky company that can go bankrupt, buy a treasury bill that can at least offset the loss.

Step 3. Keep cash
You should have a source of cash that you can use if the need arise. It may be because you have loss your job or that an investment on the cheap become available. In this recession where everybody is selling, assets are being sold very cheaply so if you have money you can buy them. Remember the Rothschild make their fortunes buying assets on the cheap. You can have cash readily available by having bond and cd ladders suitable set up so that cash is available on a regular basis.

Step 4. Time
Should your well balanced portfolio began to fall in value, then may be time is the best solution instead of a sale. remember that with time the stock market go up, and that after the recession a portfolio will regain its prerecession value quickly. So do not panic and start selling , just sit back and wait for the recession to pass.

Step 5. Sell when appropriate
Some investment may be going down and may not recover. So if you feel that a company will go bankrupt, its time to sell that stock or bond and at least recover some money. You can then use that money to buy other investments. Chances are if you buy another stock on the cheap and that stock recover your loss might be small.

Conclusion
Stock market and the economy do go down. The better prepared your portfolio is the better you can manage in this downturn. So sit tight and wait for the recovery. And keep that cash ready to swoop on that cheap house or stock.

Good luck guys.

Introduction to diversification

Diversification is by far the most important strategy that an investor must learn. It is similar to the old saying "do not put all your eggs in the same basket". It is so obvious that if someone will tell that to you you would offended.

What is Diversification?
Diversification is when you invest in a range of investment instruments that are different from each other. Diversification is done because each instruments have different risk, volatility and liquidity associated with them. Hence by investing in instruments have have different risk, your portfolio is more resilient to shocks in the economy. If the value in some investments decline, the fall might be balanced by rises in others or at least the value of the other investment might not fall as much and as a result the value of your portfolio will not fall as much.

Lets say that you invested in one stock, then in a recession the value of your portfolio will fall with the stock market. However if you buy two stocks, then one of them might fall less and reduce the fall. Consider further that you have used a third of the money to buy bonds. In a recession the value of the bond will be the same. Hence your portfolio will be further able to resist the fall of the stock market. hence as you can see it is a usual practice to have in your portfolio a mix of bonds, stocks and cash. The cash is used to meet emergency expenses so that you don't have to sell bonds and stocks. It is never a wise move to sell stocks of bonds to meet unexpected expenses. Hence a typical portfolio will have a mixture of bonds, stocks and cash. The more aggressive investors will have a larger percentage of stocks while the safe investor will have a larger percentage of bonds.When creating a portfolio that contains both stocks and bonds, aggressive investors may lean toward a mix of 80% stocks and 20% bonds while conservative investors may prefer a 20% stocks to 80% bonds mix.

You should also keep in mind that stocks come in different flavors. There are blue chip companies, medium and small size companies and start-ups that offers varying degree of risk and return. Investors can buy stocks from different sectors of the economy. Remember that different sectors of the economy are not affected in the same way during recessions. some may even be counter cyclical and rise during a recession. It is thus important to include in your portfolio stocks that are from various sectors and from companies of different sizes.
Bonds are also of various types. Bonds may be from governments, companies and municipalities. These bonds have different risks and hence have different returns. They also have different maturity dates so that if you are building a bond ladder with a bonds of maturity dates then you will have bonds that mature every year. It is therefore a good practice to have different types of bonds that have different returns and different maturity dates.

If however you do not want to go to the expense of buying all sorts of stocks and bonds you could buy a mutual fund. Mutual funds are a selection of bonds and/or stocks have have been bought by a company and you got to buy a share of them. You thus invest in the mutual fund and you get the advantages of buying stocks and bonds. Mutual funds comes in all types of flavors. you can have all stocks, different mix of stocks, all bonds, different types of bonds and different mix of bonds. The choice is all yours. You can also have index funds that buy mostly everything so that you benefit from the general trend. The choice is yours. Mutual funds are ideal for those that are starting in the investment world or don't have time to do research. However for the expert investor mutual funds is not advisable for with time the fees eat the profit.


While stocks and bonds represent the traditional investment instruments, a lot of alternative investments can be used for diversification. Real estate investment trusts, hedge funds, art and other investments provide the opportunity to invest in vehicles that do not necessarily move in tandem with the traditional financial markets. I do not however recommend them for they require a lot of professional knowledge.

A word of caution is required here. While diversification is good for the investor, there is also what is called overdiversification. At this point fees increases to such an extent that it decreases the return. Tracking the inverstments is time consuming. So you should not diversify into too many investment instruments.

Conclusion
Your personal time frame, risk tolerance, investment goals, financial means and level of investment experience will play a large role in choosing your diversification strategy. Start by making a financial plan and choose the appropriate mix.

Good luck.

Stocks have higher return than bonds

Two of the most common investment instruments are stocks and bonds. On average stocks have yielded greater return compared to stocks. So for a long term investor it makes sense to invest in stocks instead of bonds. However the higher return come at a price. Stocks are more volatile and risky while bonds are more secure and their values change less.

Bonds are debt instruments that are repaid at a fixed interest rate. They are issued by companies, governments, municipalities and so on. You are guaranteed to recover your principal together with some interest. The interest cannot change a lot. Unless you sell the bond before its maturity so that you can get a profit greater that the interest rate you initially bought the bond with. However the profit is only a tiny amount greater than the amount you would have obtained had you hold the bond to maturity.

Stocks are however partial ownership in a company and this give you a right to the profit of the company. Hence you get you return either by dividend which is a part of the profit of the company and partly from increase in the value of the shares. As a result if your company is successful the value of the shares and the dividends will increase with time. Hence on the long run the return of stocks has always been greater than the return of bonds.

However on the downside when investing in stocks you are taking a greater risk since the profit of companies cannot be predicted. The company can be highly profitable at a time and make a loss at other times. With this greater risk come the possibility of greater return. However the long term trend of the economy is up and as a result the total profit of the companies will always be up even though a few companies here and there might go bust. Combine this greater return possibility with a good diversification plan and you will see that on the long run stocks will definitely outperform bonds even if you make a loss in one or two stocks.

Stocks are also better able to keep up their values in inflationary time. The value of stocks can increase with time while the principal +interest of bonds can have some difficulties to keep up with inflation.

Conclusion
Bonds are generally associated with certainty and less risk as a result the return is certain and as a result it would be less than that of stocks since they are riskier and more uncertain. They should therefore have greater return. Thus depending on your strategy, risk tolerance, age and plan you could invest in bond alone, in bonds and stocks or in stock alone.

Should I buy gold?

One of the most important questions that investors are asking themselves at the moment is whether to buy gold. There are a lot of investors out there who fearing inflation or the loss of value of paper money are asking themselves this question: Should I sell my stocks and buy gold? There is no definite answer, however each investor should think about the risk and benefits of holding the metal and act accordingly.

Benefits of holding gold

1. Gold preserve wealth
Gold is very important to preserve wealth especially in troubled times. Gold and silver had existed for thousands of years and has not loss value. It keep up with inflation. It can simply be said that one ounce of gold was as valuable in the 30s as it is today. However a dollar was worth much more than it is today. Unless appropriately invested so that it can earn above inflation return a dollar will lose value over time.

2. A hedge against inflation
Preserving wealth is very important in times of high inflation. Very few investment instruments can keep up with high inflation. Many economists are forecasting high inflation in the years to come due to the huge amount of money being injected in the economy. They are also forecasting a declining dollar as nations shift away from the dollar as a reserve currency. Gold is the ideal instrument to preserve your wealth if you believe them. With rising inflation, gold typically appreciates. You would probably remember the 70s when high inflation decimated the investment of many people, whereas those who invested in gold preserved their wealth until inflation was back under control in the 80s.


3. Can be used in troubled times
Some people called survivalists are forecasting a major breakdown of the economies of different countries. If such a thing happen, then only hard assets like gold, silver and land will have value. So these survivalists are buying gold to this effect. One example is Zimbabwe where the dollar is worthless. In such an economy only gold and silver will have value. So if you think that your economy will collapse then it would be a good idea to invest in solid gold.

4. A part of a diversified portfolio
The last reason to hold gold is as part of a diversified portfolio. You will allocate a certain percentage of your portfolio to gold because of its ability to hold its value. This will reduce the volatility of your portfolio. You will thus diversify your investment which is always a good thing. If you hold gold in order to diversify your portfolio, the percentage should not be too high.

Types of gold investments
The following are possible investments in gold.

1. Gold Futures
A future is a contract on commodities that gives you the ownership of future gold that has not yet been mined. It is like owning next years wheat harvest.

2. Gold Coins
Coins in gold that are minted and sold mainly for collection. They are however more valued that the value of the gold in them.

3. Gold Companies
Shares in gold mining companies or companies that service or support gold miners.

4. Gold ETFs
A security that will track the price of gold, gold index funds and so on. Its value will mirror the price of gold.

5. Gold Mutual Funds
A fund that will buy stocks in various gold related companies. You will invest money in the fund. It will be like owning gold stocks.

6. Gold bullions
Gold in bulk in the form of ingots or coins. They can be bought in real or stored by third parties. It is unclear what would happen to your gold if the storing companies go bankrupt.

7. Gold jewelry
Jewelery are more expensive and the weight of gold in it is less that the price of the jewelery.


As you can see gold is a very versatile investment instrument. Whether you want to hold real gold or benefits from the rising price of gold is up to you. However the rising in the price of gold in the near and medium term is certain. Hence it is a must for every investors to either hold real gold or at least invest in gold shares.

A last piece of advice. I see with great suspicion the proliferation of companies that buy gold and store it for you. I would prefer to hold my physical gold in my own hand. A paper saying that i own gold is not the same as owning real gold.


Good luck in your future gold investments.

Asset Allocation - How to allocate your money in your portfolio

After a person has decided to invest, the most important decision a person has to make is asset allocation. i.e. How much money will be allocated to each asset class.

For recapitulation their are several asset classes that one can invest their money in. I would leave out the most difficult and complex which are not worthy to invest into.

1. Stocks
2. Bonds
3. cash
4. Fixed deposits or certificate of deposit
5. Precious metals

The first decision to take is how much risk you can tolerate. You can learn about risk and risk tolerance here. Because some of those assets can vary widely in value, can crash and be wiped out, then your tolerance such risks and changes in the value of your portfolio will determine how much you allocate in each class.

The following list the asset class from the most risky to the most safe.

stocks, precious metals, bonds, cash, certificate of deposits

However the riskier an asset class the more the return associated with it. So those that want to have high return will have to increase the percentage of risky assets in their portfolio.
Hence there are several ways to allocate assets in a portfolio based on the tolerance of risk and the return required.

High risk, high return
100 % stocks and high yield bonds

medium risk, medium return
50 % stocks, 25 % cds, 25 % bonds

low risk, low return
25 % stocks, 25 % cds, 50 % bonds

Inflation hedge
75 % gold and silver, 25 % bonds indexed with inflation

Hyperinflation portfolio
100 % gold and silver

I choose the medium risk and medium return portfolio. I think that it can cater for all types of catastrophe in the market.

The choice is yours guys.

Investment strategies

An investor must be able to analyze company financial statements in order to make a personal opinion on the value of a company and whether it is worthwhile to invest in that company.

Contain different investment strategies that can be used in these troubled time.

Has the market bottomed yet?

How to plan your investments and spendings.
Asset allocation. How to allocate your money in your portfolio.
How to be a successful investor?
Stocks have higher return than bonds
Introduction to diversification
What is an index fund?
How to survive in the downturn?
5 tips to survive a bear market
What is compounding?
What is inflation and how does it affect your portfolio?
Fear and greed are your worst enemies
Efficient Market Theory
Fees and commissions and how they affect your portfolio.
Active trading - The key to beating the market
Risk and return
What is a bond ladder?