Basics of Investing
By Saghir Aslam
Irvine , CA
(The following information is provided solely to educate the Muslim community about investing and financial planning. It is hoped that the ummah will benefit from this effort through greater financial empowerment, enabling the community to live in security and dignity and fulfill their religious and moral obligations towards charitable activities)
When you invest in a company, you become an owner of the company with a vested interest in the company’s performance. Whether you're managing money for a household or for a multinational corporation, you want the money you invest to give you the best possible return. This article discusses basic investing and portfolio-planning concepts that can help you make wiser choices.
If you find yourself with cash reserves that you’re not ready to invest or spend immediately, a short-term investment buys time and earns interest while you decide how else you’d like to use the money. Short-term securities offer relative safety and liquidity at the same time.
Three short-term investments -- available from full-service investment firms -- are money-market mutual funds, brokered certificates of deposit and Treasury bills. We'll discuss each in turn.
· Money-market mutual funds. Investment firms typically offer a variety of professionally managed, diversified money-market portfolios investing in high-quality, short-term debt instruments. Money-market funds can be used as a place to hold funds waiting for a potential investment opportunity. Be aware that the yield will fluctuate on a daily basis, depending whether interest rates go up or down.
Mutual funds are sold by prospectus. Please consider the fund’s investment objectives, risks, charges and expenses carefully before investing. The prospectus, which contains this and other information, can be obtained from your financial advisor. Read it carefully before you invest. An investment in a mutual fund is neither insured nor guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although a money-market fund seeks to preserve the value of your investment at $1 a share, it is possible to lose money by investing in the fund.
· Certificates of Deposit (CDs). Brokered CDs, available from most full-service investment firms, offer an alternative to traditional bank products. Usually available for $1,000 each, CDs can be sold before maturity through any brokerage firm that maintains a secondary market (large blocks of federally insured CDs available for resale to investors). Maturities typically range from three months to 30 years. However, keep in mind that if you sell your brokered CD before maturity, you may receive more or less than your initial investment, depending on current interest rates and any applicable penalties for early withdrawal. Before investing, take careful note of how interest is compounded and of the actual effective yield. By staggering the maturities of your CDs between three, six and twelve months, you may be able to balance liquidity with competitive yields.
· Treasury bills (T-bills). T-bills are guaranteed by the government and are available in a variety of maturities. They are sold at a discount; at maturity, you receive the full face value. The minimum denomination is $1000, but the actual cost of a T-bill varies according to its maturity and interest rate. T-bills are fully negotiable, and T-bills purchased from an investment firm can be sold before maturity without a penalty. Keep in mind, however, that selling a T-bill before maturity may result in a profit or loss, depending on interest rates. As interest rates generally increase, the prices of fixed-income securities generally decline.
Intermediate- and Long-Term Considerations: Risk and Reward
Investing for the intermediate term (1 to 10 years) and the long term (10 to 30 years) makes it important to consider the risk/reward characteristics of any prospective investment. Before committing funds to any investment, you must consider these questions:
· What is the investment goal? What do I want this money to do?
· How much time do I have? When do I plan to sell the investment I buy today?
· What annual rate of return on investment (ROI) must this investment achieve to meet the investment goal?
· How important is it to preserve this capital? How much risk can I afford to take in search of the desired ROI?
Generally, the greater the risk you're willing to take, the greater the reward you may receive if the investment turns out well. Of course, greater risk can lead to greater losses if the investment turns out poorly. This is true for all the major types of investments: stocks, bonds and mutual funds that invest in stocks and bonds.
Risk and Reward: Common Stocks
Common stocks are equity securities. That is, they represent ownership in the issuing corporation. As the assets and liabilities of the corporation fluctuate, the stockholders' equity fluctuates, and so does the book value (balance-sheet value or assets minus liabilities) of your shares. Stock prices can also fluctuate with investors' changing perceptions of the prospects for the company.
From the company's earnings (profits), the board of directors determines what portion will be distributed to stockholders as dividends and what portion will be retained to enhance book value or reinvest in the business. Thus stocks can offer two components of return: dividends and the change in the stock's price.
Neither the stock's future price nor the payment (or amount) of future dividends is guaranteed. If the company fails, its creditors (bondholders) have the first or senior claim on its assets. Common stockholders, as the owners of the company, are paid last.
In return for assuming greater risk, a stockholder has the opportunity for potentially greater reward than holders of some other types of investments. If the company is successful in increasing profits over the years, the stockholder should benefit. Historically, over the long term, stocks have generally outperformed bonds. In exchange for less risk, the bondholder generally accepts the potential for less reward.
In considering a stock investment, think about the following questions:
· How is the company that issued the stock doing? Does it have a record of long-term earnings growth? Are the senior managers responsible for its success still in place? Does it have a leading position in its industry? Is it threatened by strong competition or a tough regulatory environment?
· How will the company's products and services likely fare over the term of this investment? (Continued next week)
(Saghir A. Aslam only explains strategies and formulas that he has been using. He is merely providing information, and NO ADVICE is given. Mr. Aslam does not endorse or recommend any broker, brokerage firm, or any investment at all, or does he suggest that anyone will earn a profit when or if they purchase stocks, bonds or any other investments. All stocks or investment vehicles mentioned are for illustrative purposes only. Mr. Aslam is not an attorney, accountant, real estate broker, stockbroker, investment advisor, or certified financial planner. Mr. Aslam does not have anything for sale.)