The Hindu Business Line : Not investing your money is also risky

Why do we invest? There can be many reasons, but the most important one, according to Esmé Faerber, is "to fund our retirement because we are living longer."

Today's investments form the basis for future purchasing power, and poor investments can lead to negative returns, she explains in All About Investing from Tata McGraw-Hill (www.tatamcgrawhill.com) .

The author is a CPA, and a professor of business and accounting. Her book is `a step-by-step guide to putting your money to work for you... from stocks to bonds to options and futures trading.' Begin with five steps that outline the investment process.

Five steps

First, determine your financial objectives (e.g., buying a car before 2008, funding a college education in 2015). Second, allocate your assets; that is, assign funds to different categories of investments. Funds that you need on demand should be invested in money-market securities, advises Faerber.

Third step, identify your investment strategy, whether active or passive. Fourth, select your investments. "Passive investors choose diversified assets in each class of investments," points out the author. Active investors, in contrast, assemble a portfolio after studying the fundamentals of companies to find undervalued securities; they sell the securities when they turn overpriced. Step five is to evaluate the portfolio periodically, "because a change in your circumstances might necessitate a change in your asset allocation plan."

The chapter on risk and return defines risk as `the variability of returns from an investment.' Risk is what weans many investors from stocks and "prompts them to keep their money in so-called safe bank accounts, CDs, and bonds." Faerber reminds that returns from these passive savings vehicles often have lagged the rate of inflation. "Although investors will not lose their capital, they risk losses in earnings owing to inflation and taxes when they merely hold cash and cash equivalents."

Risk management

It may be sobering to realise that even the most conservative investment involves some element of risk. "However, not investing your money is also risky. For example, putting your money under the mattress invites the risk of theft."

Understanding risk involved in different investments isn't enough; you need to be aware of `your feelings towards risk.' Means? `How much risk can you tolerate?' asks the author. And there are more questions: "How nervous do you think you'll be about your investments? Will you check the prices of your stocks and bonds daily? Will be able to sleep at night if your stocks decline in price from their acquisition prices? Will you call your broker every time a stock falls by a point or two?"

If you have a small amount of money to invest, mutual funds can be a better alternative, counsels Faerber. "Also, the professional managers of these funds have quicker access to information." There can, however, be a strong argument for buying individual securities, especially when the rates of return are better than what the funds offer.

One of the many tips in the book is on using the Net to find value and growth stocks. "Use a stock screener on www.finance.yahoo.com or www.moneycentral.msn.com to see a list of some current growth and value stocks," writes Faerber. "For growth stocks, enter higher P/E ratios and higher earnings per share growth estimates. For value stocks, enter low P/E ratios and lower earnings per share growth estimates."

Ever heard of DRIP? The acronym stands for dividend reinvestment plan, which allows shareholders to reinvest their dividends in additional stock rather than receiving dividends in cash. The advantage, as the author explains, is to make shareholders forced savers. An idea that is worth implementing closer home, with apt changes to tax law.

The chapter on bonds begins from the basics. "A bond is a negotiable debt security whereby an issuer borrows money and in return agrees to pay a fixed amount of interest over a specified period of time and pay back the principal amount when the bond matures," defines Faerber, without presuming any prior knowledge on the part of readers. She then explains how bond prices and interest rates are on two sides of the see-saw, what different risks are to be faced by bond investors, and takes you on a tour of YTM (yield-to-maturity) and yield curves. She cautions that pricing transparency is poor in bonds, and that investors are seldom aware of the spreads.

Within less than 40 pages, spread over two chapters, the book covers options and futures. Graphs and examples make learning easy, in sections such as `profit and loss from buying the stock versus a call option.' In a discussion titled `What makes trading futures different from trading stocks?' you can read about margin, "the amount of equity that must be deposited when purchasing securities."

While margin requirements for purchasing stock is 50 per cent of the purchase price, it varies between 2 per cent and 10 per cent for futures contracts, notes the author about the US position. Closer home, as you may remember, the BSE and the NSE recently announced reduction in exposure margins for cash and derivatives segments, to help brokers hassled by the big falls in the bourses.

Must-read for the whole family is the final chapter on `real estate, precious metals, and collectibles.' The last category includes "art, antiques, vintage cars, rare books, Persian rugs, coins, stamps, baseball cards and other items that offer the potential for appreciation."

A book that you can include in your list of collectibles, for the ready value it offers!

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