What is an interest-based security?

 

There are two ways in which securities are issued. They are either issued and interest is earned on the principal, hence the term interest-based securities, or they can be issued at a discount or at a premium, hence the term discount based securities.

In this post I am going to talk about those securities that are interest-based.

When you talk about such securities the investor, you, will invest a certain amount of money called the principal. This is the amount that you would invest at the beginning of the contract and at maturity you will receive this same amount. 

Then the return every year on this amount that is invested is called the interest. The interest earned will be calculated using the interest rate on the investment. The higher the interest rate the higher the interest earned.

Hence generally this principal is invested for a length of time ranging from 7 days to five years. The interest rate of the investment also depend on the length of time for which the principal is invested. Generally the longer the time the higher the interest rate. This is because your money is locked in the investment for a longer length of time. You will thus have to be compensated for the decrease liquidity and the greater risk taken.  

Now there are two ways in which interest will be accrued on the principal. It will be either a simple interest  whereby the interest will be calculated every year on the principal alone. Hence you will obtain the same interest every year.

You can read a post on simple interest here.

The other type of interest is the compound interest  whereby the interest earned every year is calculated on the principal and the interest earned in previous years. You can read a post on compound interest  here.

strategies of the successful investor part 2 :Time is your best friend

As I have written in an earlier post, time is the best friend of the investor. As we have seen in the first post you will have to draw up a plan. this plan will contain information about for objectives, risk tolerance, risk tolerance and asset allocation.

However the time that you have will impact on these four aspects on you investment life.

I am going to take the examples of a person saving for sending his child to university and for retirement and talk about how the time aspect would affect the achievement of these objectives.  

Suppose that a person who is 20 years old want to retire at the age of 60 years old and also to save money for a child who has just been born. Such a person has 40 years to grow his portfolio for his retirement and 20 to send his child to university. Such a person has time on side.

This person can afford to be risk averse and conservative and invest in a greater amount of safe assets. This person can also invest a smaller amount  of money every month because he has the advantage of compounding. Compounding will ensure that his money will grow with time even with small monthly investment. Such a person would be able to achieve his objectives with no problems.

On the other hand if a person is 35 years old and want to retire at 60 years old and want to send his child to university in 10 years then this person will not have time on his side. This person will have to invest more aggressively and cannot afford to be risk averse and must choose assets with greater riskiness but with greater return. Such a person will not also have the advantage of compounding and as a result will have to invest more every month. This person may have no choice but to delay retirement or the time set to attain the objectives.

The lesson that we can learn today is that if you have time on your side then you are a lucky guy. But if you do not have time on your side then it would be harder.