What guarantees a steady and reliable source of income in the future is investment. Investing in the right firm or company that will guarantee the safety and security of your assets will not only bring to you future streams of income but also a great peace of mind.
When investing your capital with any company, ensure that the company or firm is properly licensed and registered. Do your own findings about the company, how long have they been in operation, how do they operate and when do dividends or interest are been paid out.
Ascertain if it's on a weekly, monthly, quarterly, biannual or yearly basis before dividends on your investment are paid out. Find out the interest rate and the amount of capital involved for the investment, as some companies has a minimum amount required before you can invest.
What is Investment?
Investment is the act of redirecting resources from being consumed today, so that they may create benefits in the future. Investment can also be referred to as the use of assets to earn income or make profit.
In order words, investment is the bedrock which guarantees future streams of income. The wealthiest individual in the world became wealthy through successful investment of their capitals or money.
The Basic Ways People Invest
There are two most common ways in which people invest, they are stocks and bonds.
What is a stock?
A stock is a representation of ownership in a public company. They can be risky to purchase as their prices can change dramatically and unpredictably. However, the bigger the risk, the higher or bigger of the potential reward.
There are two ways in which stockholders make their money, they are as follows.
1. Dividends
2. Capital Gains
What are dividends?
Dividends are profits paid out four times a year to all shareholders. The size of dividends depends on the company's profit.
What are Capital Gains?
Capital Gains simply means when a stockholder sells their stock more than they originally paid for it or bought it. It also means, when a stockholder sells their stock for a profit.
If a stockholder made a profit, it is a capital gain, but when they lost money, it's referred to as capital loss.
Stock Exchange And Brokerage
A stock exchange is a market where buying and selling of stock takes place. Brokerage firms on the other hand are business firms that help stockholder trade stocks and sometimes even deal out stocks.
This days anyone can easily have an access to the stock exchange using their phones through apps that offers brokerage services.
What is a Bond?
A bond is essentially an IOU issued by a corporation or by some level of government. When you buy a bond, you're loaning money in return for a guaranteed payout at a later or specific date.
Bonds are usually a more stable investment that stocks.
Components of Bonds
There are three (3) components of bonds:
1. The Coupon Rate
2. The Maturity Date
3. The Per Value Amount.
The Coupon Rate
The Coupon Rate is the interest rate that a bond issuer will pay to the bondholder.
The Maturity Date
The time in which payments are due for bondholders, is called the bond maturity date.
The Per Value Amount
A bond's per value amount is assigned by whoever that issues the bond, it is the amount to be paid out to the bondholders at maturity.
Financial System
In order for any Investment to thrive or take place, an economy must first have a good financial system, which is the network of structures and mechanisms that allows the transfer of money between the savers and the borrowers. When people save their money, they often are actually lending funds to others.
Savers and borrowers may be linked directly through what is known as financial intermediaries.
Financial Intermediaries
Who are the financial intermediaries?
Financial intermediaries as the name implies are institutions that help move funds or money from savers to borrowers. Financial intermediaries includes banks, mutual funds, hedge funds, and pension funds.
Mutual Funds
A mutual fund brings the savings of many individuals and invests this money in a variety of financial assets, such as stocks, bonds etc.
Hedge Fund
A hedge fund is a private investment organization that employs risky strategies that can often make huge profits for investors. Generally, these investors already have tremendous wealth and are knowledgeable about Investment.
Pension Fund
A pension fund is an income that some retirees receive after working in a certain number of years or reaching a certain age. In some cases, injuries may also qualify a working person for certain pension benefits.
Employers setup pension fund by collecting deposits, and pension fund managers then invest those deposits in stocks, bonds and other financial assets. In general, the best way to invest your money is to put it in a diverse range of securities.
This reduces risk, especially when stock or bond prices drop. Therefore, people often invest some of their money in more risky ventures, then invest the rest in more stable funds.
It is also better to invest money earlier in life. This is because one of the greatest assets is time, the longer your money is invested in securities the more it will grow. Let put in another way, you make more money on the money your money already makes.
When investing money, it is crucial to consider the two types of interest, which are the simple interest and compound interest.
Types of Investment Interest
There are two types of interest gotten from any Investment, they are as follows.
1. Simple Interest
2. Compound Interest
What is Simple Interest?
A simple interest is an investment interest based on the principal amount or capital of either a loan or a deposit.
What is Compound Interest?
A compound interest is an interest that is based on the principal amount or capital and the interest that accumulates on it every period. This, this can be regarded as "Interest on Interest".
Simple Interest Formula
Simple Interest is only calculated on the principal amount of a loan or deposit. The formula is as follows.
A = P x (1 + rt).
Where A = Final Amount
P = Initial Principal Balance
r = Annual Interest Rate
t = Time.
Compound Interest Formula
Compound Interest rate is calculated based on both the principal and interest accrued. The formula is as follows.
Where A = Final Amount
P = Initial Principal Balance
r = Number of times interest is applied per period (usually in a year)
t = Number of Periods elapsed.
Example 1: Mr. Rodney loaned $10,000 to a friend and he agreed to pay it back in 5 years with an annual simple interest rate of 5%. After 5 years, what will be Mr. Rodney's interest on the loan?
Solution:
A = P x (1 + rt)
A = ?
P = $10,000
r = 5% (0.05)
t = 5 years
A = 10,000 x (1 +( 0.05 x 5))
A = 10,000 x (1 + 0.25)
A = 10,000 x 1.25
A = 12,500
That is to say, Mr. Rodney's interest after 5 years is $2,500. The total amount that will be repaid to Mr. Rodney will then now be a total of $12,500, which is the original principal plus the interest accrued.
Example 2: Assuming Mr Rodney loaned same amount ($10,000) to the same friend and he agreed to pay it back in 5 years, with an annual compound Interest rate of 5%, and the interest is compounded on a monthly basis or 12 times in a year.
What will be Mr. Rodney's interest after 5 years?
From the image above, Mr. Rodney's compound interest after 5 years will be $2,833. Everything altogether will become a total of $12,833.
This example above shows that compound interest is far more better to simple interest when investing your money. Whenever consumers evaluates an investment, they must balance the risks involved with the rewards they expect to gain from the investment.
Finally, the higher the potential return on an investment, the riskier that Investment would be and reverse is the case on a lower potential return.
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