Returns in investing is a by product of what you have studied. Your goal should not be just to look at the earnings but rather to learn the process on what produces earnings. In this article, our resident risk expert, Rienzie Biolena will share on why returns are just the beginning and that there are other factors to consider when investing.
I want you to build a solid foundation in investing so that you would be able to make sound choices in your investments.
In investing, it is very tempting to seek after returns. After all, who would not want to beat inflation? Or ride the upswing of the stock market when all are heading north? Or jump in when the Philippines has become investment-grade? Truly, who would not want Returns?
But in the world of investing, Returns are only the beginning. It is just a part of the battle. Because focusing just on Returns would leave the investor blindsided on the other factors to consider which unfortunately, a lot are not aware of. After Returns, the investor must also look at these two: Risk and Friction Costs as they also affect performance.
Risks. One fundamental Rule of Thumb in investing is “the higher the return, the higher the risk; the lower the return, the lower the risk.” This is generally true for any stock, bond or portfolio holdings. For instance, stocks that give higher than average returns can also dip much lower than the average, i.e., it is more volatile. It can go way up and it can also go way down. One mining stock I know has its share price risen by four times in a matter of 4 months, but has fallen to just a third of that share price nowadays. Thus, in selecting stocks for your basket or portfolio of investments, it is best to manage risks.
Basic to managing risks is diversification: spreading your holdings into different stocks such that over-all risk is minimized. One good principle would be to invest in negatively correlated assets: such that when one goes up, another goes down and vice versa. That way, wherever the market goes, you emerge a winner.
Diversification should also be done in the portfolio of investments as a whole: diversifying into stocks, bonds, and other asset classes such as real estate, hedge funds, or even forex. Diversification may also mean going into foreign markets as well.
Friction Costs. These can be transaction fees, broker’s fees, management fees, taxes, and other fees and charges deducted to your investment after the returns.
For instance, in the stock market, investors pay brokers commission (maximum of 0.25% of gross trade amount of P20, whichever is higher), clearing fee of (0.01%) of gross trade amount, PSE Transaction Fee (0.005% of gross trade amount), sales tax (for sellers only, 0.5% of gross trade amount), and even the 12% VAT on broker’s commission.
For Government Securities, interest income are also taxed with 20% final withholding tax. In the case of real estate, there are capital gains tax, business tax, documentary stamps tax, transfer tax, registration fee, realty taxes and broker’s fees, depending if you’re the buyer or seller.
In the case of managed funds, fees may range from 0.5% to 2.0%. They may be giving decent returns, but if you add them up again to the returns that you are getting, then these will redound to significant amounts, most especially if compounded over a long period of time. That is why in foreign investors are very much conscious of the management fees that funds charge because they know that it eats up on their returns. And recent studies in the US show that funds with higher fees tend to give lower returns.
With these tripod of investing: Returns, Risks, and Friction Costs, investors can now be more effective, gain more returns, and be cost- and tax-efficient with their investments.
Rienzie P. Biolena is one of the pioneering Registered Financial Planners of RFP Philippines. He is also an Accredited Investment Fiduciary of Pennsylvania-based fi360, a Certified Financial Consultant from Institute of Financial Consultant-Canada, and a Chartered Wealth Manager of the American Association of Financial Management.
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If you’d like to learn more how to invest in the stock market and learn how to make your money work hard for you. I’d like to invite you to our upcoming events:
- July 20th Stock Smarts Cebu 2014
- July 23rd Retire 2014: The No Nonsense Retirement Planning Workshop
- July 27th Stock Smarts Singapore 2014
- August 10th Money Smarts Davao
- August 14th Stock Smarts: Basics Manila
- August 17th Money Smarts: Cagayan De Oro
- August 29th Stock Smarts Conference Dubai 2014
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