This article was written by Kelly Palaganas. Kelly Ramos-Palaganas is an artist turned freelance writer. To learn more about her work, click here.

This is the fourth part in a series of posts called “Increase Your Income”. By the end of this series, you’ll know the concrete steps you need to take to make more money. Here are the previous installments of the series: Part 1: Make the decision to move forward Part 2: Negotiating a Raise Part 3: Selling Products Part 4: Freelancing

“Savers are losers,” warns best-selling author Robert Kiyosaki. Though not all of his investment advice is sound advice for everyone, he’s right on this point. Savers are losers.

But “loser” here doesn’t mean our typical connotation of a person who is a loser – someone who is unsuccessful, misfit, walang kwenta.

“Loser” here means someone who has taken a loss. This is because if you keep a large bulk of your money in savings, you are actually losing that money. You are losing it in bank fees, you are losing its earning potential, and you are losing it to inflation.

For example, typical savings accounts in the Philippines have an interest rate of 0.50% to 1.75%. If you have more than Php 500,000 in your savings account, this can go up to 3%. (Per annum)

Interest from time deposit accounts usually range from 1.75% to 3%. If you can deposit more than Php 500,000, then this can go as high as 5%. (Per annum)

This sounds like your money is just sitting there, multiplying by itself right?

The Stormtroopers just got their investment earnings

Unfortunately, that’s not the case, especially when it comes to inflation. Basically, inflation is the rise of the cost of commodities. As inflation rises, the purchasing power of your money decreases.

When I was a kid in the 1980′s, we still had coins for “isang centavo” (square, with Lapu-lapu’s face on one side). Now, it makes no sense for the government to make those coins, because the cost of manufacturing them is definitely more than one centavo each. Also, even if we had these coins, anong mabibili mo sa kanila?

Another example where we experience inflation in our daily lives is the cost of transportation. In 2001, the minimum fare for jeepneys was 4 pesos. Now, it’s twice that.

Check out our Philippine inflation rate numbers for the past 5 years (courtesy of Wolfram Alpha):

Basically, this means that if you had your money sitting in savings accounts for the past 5 years, unless your account’s interest rate was more than the average inflation rate, you were actually losing money. And it’s highly unlikely to find an account here that earns above inflation.

So keeping the bulk of your assets in these bank accounts and time deposits doesn’t mean you earn more money. It means you’re just losing less than if you kept your cash hidden in a jar somewhere.

This is why everyone should consider investing their savings if they won’t need it soon, or if they don’t need easy access to it. Examples of savings that you might not need to invest are emergency funds (which you’ll need easy access to) and savings that you’ll be spending within a year (like savings to buy gadgets, vacations, etc.)

Investing 101

Investing your money is a faster way of making it grow, since most investments give you bigger returns than interest earned through bank deposits, and can help you beat inflation.

However, investing also entails some risks, which is why most of us are hesitant to start investing in the first place. You need to know the basics of investing, the instruments you can invest in,  and assess your own financial situation before making any investment decisions.

While it’s almost impossible to predict the future of investments, there are certain “rules” that apply when you look at investment history over decades:

Risk vs. reward. The relationship between risk and reward is almost unbreakable. This means that investors are rewarded based on the amount of risk they expose themselves to. The higher the returns promised, the higher the risk. If you want a low-risk investment, then expect lower returns.

You can’t predict your investment’s returns, and neither can “experts”.  You can spend days or weeks charting the history of your investment, but there is no way to foresee its future. Past performance does not guarantee future performance.

Take note of those ads that tell you something like “Our mutual fund earned 14% in the past year.” So what? This just means that anyone who bought the fund last year and sells his shares now made some money.

You can’t rely on so-called “expert advisers”, either. This article from Get Rich Slowly explains why.

It’s important to know investing history.  While you don’t need to know all the details of the world’s investing history, it’s best to know the important points – especially the parts where most investors made or lost a lot of money. Some examples are the dotcom bubble or the Great Depression. (Google these, it’s worth it.)

Do proper asset allocation. An investment strategy is based on time frame, risk tolerance, and goals. This must change over time, since your life situation changes. For example, an investor in her 20′s can afford to have around 70% of her retirement investments in stocks, since they are riskier and she won’t be needing them within the next 3 decades. But someone who is expecting to retire in 5 years should have most of their investments in safer vehicles like time deposits or bonds.

Diversify. Sure, wealthy Filipinos who have a lot of daily inside knowledge on publicly traded companies can get rich handpicking their investments one by one. But the average Filipino does not have the time, resources, or skill to risk most of their funds into a handful of investments. This is why most of us should diversify and own a wide variety of investments, depending on our needs.

Don’t invest in what you don’t understand. Before you choose an investment instrument, you need to understand it enough that you’d be able to explain your investment to a five-year old. This means that you truly know what you’re getting into.

Avoid ALL hidden costs. Almost all investments have associated costs, and you need to know about them. This includes the tax you have to pay, the investment manager’s fees, transaction costs, etc. Don’t be caught by surprise with fees that you didn’t expect.

Investing Psychology

One aspect of investing that is often overlooked is psychology. No one is above this, no matter how smart you think you are. We are all prone to irrationality and various biases. The best thing you can do is to acknowledge these and keep yourself in check so that you can tell when you’re experiencing it. Here are some examples:

• Loss aversion – When faced with a decision that has the possibility of higher gains, we would rather avoid losses instead. For example, many investors sell low – despite the common sense “buy low sell high” rule.

• Sunk costs — Sunk costs are irrecoverable money already spent in an investment. Even if you already spent a lot in the past, it should not influence future decisions. This is why people keep making monthly payments for cars that they realize are too expensive to keep, and why we pay for gym memberships we don’t use - “Sayang naman pakawalan eh, binabayaran ko na.“

• Following the herd (herd behavior) — This is a tendency to follow stock market trends and hearsay regardless of common sense. It is said to be a factor in market crashes and financial bubbles.

• Following “experts” – Our decision-making abilities seem to shut off when presented with expert advice. We stop deciding for ourselves and weighing the risks.

Now that you’re aware of your psychological flaws and biases, it’s time to evaluate your financial goals and situation so you can choose your investments wisely.

Ask Yourself These Questions…

1) Why am I investing?

There are 2 reasons why you invest: either for income or for capital growth.

The main goal of income investing is focusing on a constant stream of cash, rather than bigger returns. When you do this, you want to use your investment income NOW rather than waiting to use it later.

The second reason is investing for growth. As mentioned earlier, young investors whose goal is capital growth can be more aggressive and take riskier investments than older investors whose main goal is the preservation of capital.

It’s also possible that you’re investing for something specific that’s tied to your life goals. These include investing for retirement, for a college fund, to buy a home, or to fund a vacation. These goals are about how you want to spend your money at some future date.

It is important to know your goals before you start looking through the confusing array of investment choices. It helps you to determine your own investment style and stay focused on your objectives.

2) When do I need it?

You can have short term (1 to 2 years), medium term (3 to 5 years), and long term (more than 5 years) investment goals. You need to know if your investment goals are short-term, medium-term, or long-term, so that you can make more accurate estimates of the capital you’ll need and how much risk you are willing to take on. Here are some examples:

• People typically invest for retirement, which is a long term investment goal. The further away you are from retirement, the more risk you can take on.
• If you want to invest your emergency fund, this should be considered a short-term investment, since you need it to be accessible. You can put it in time deposits or low-risk funds.
• Investing to buy a home is an example of a medium-term goal. You need to find stable investments that can give you good returns if you keep your money in there for 3 to 5 years.

3) How much will I need?

Once you have identified your reasons for investing and your time-bound goals, it is easier to answer the question of how much. You’ll need to calculate your target amount as accurately as you can.

If you are investing for retirement, estimate the monthly income you will be comfortable with. If you are investing for your children’s education, find out the current tuition fees and estimate how much they’ll cost by the time they’ll need it.

Just don’t forget to factor in inflation when you’re doing your computations.

Now that all these crucial questions have been answered, you can look at all investment possibilities and decide with these goals in mind. 

What can you invest in?

Here are some examples of investment instruments:

• Business - We already discussed this in previous parts of this series, under “Selling Products” and “Selling Services”, so we’ll elaborate on the other investment instruments instead.

• Stocks or equities — when you buy stocks you are entitled to a share of a company’s assets and its profits. Your investment is dependent on market forces. The risk is greater but the returns could be substantial as well.

• Bonds — if stocks are equities (capital), then bonds are debts (loans). When buying bonds, you are essentially lending your money. You get paid interest at regular intervals and then the principal amount at the maturity date. Bonds are fixed-income securities.

• Certificates of Deposit—a CD is a savings certificate issued by a commercial bank when you make a time deposit. It specifies a fixed interest rate and a maturity date. Rates rise in proportion to the length of time you choose before maturity date.

• Mutual Funds—this is a diversified type of investment that you can make even with limited capital, since money is pooled in with other investors. Here are examples of some subtypes of mutual funds:

• Equity funds — also called a stock fund. Get this if you wish to invest primarily in stocks. This is the most popular; with the highest risk but giving the most in possible returns.
• Fixed-income funds— also known as bond funds. They let you have a long term, fixed regular income investment in governments and corporations. Not so risky, but they have a lower return than an equity fund.
• Money market funds— your investment is on short term debt securities of one year or less. Short term, less risk, less returns; but higher yield than a savings account.

• UITFs—Unit Investment Trust Funds are similar to mutual funds except that these are managed by banks and not investment companies.

• Properties (real estate)—a well-known form of real estate investing in the Philippines is in housing or condo units which you could buy & sell or put up for rent. It requires a bigger capital but if you make informed decisions and manage your properties well, you may get high returns.

Unlike saving, most of your investments are risky because the preservation of your funds isn’t insured by the PDIC. Even then, investing is a great way to increase your income and make your money work for you. To alleviate the risks somewhat, it is better if you are well-informed and focused on your investment goals before you dive in.

Do you invest your money? If so, how do you make your investment decisions?

Photo by Flickr user jdhancock