Ep3. Traditional Investments
From stocks to bonds
So far, what we learned was just superficial. From now on, let’s go deeper. How much do you know about traditional investments? Is it the first time? It’s okay. Simply speaking, how much do you know about stocks and bonds?
Stocks and bonds are fundamental in markets. In this post, we will explore those 2 classes. They are not just investment assets, but also important tools in the economy. Learning their history, types, and roles in the markets, we will learn how to use them to construct portfolios, manage risks, and maximize profits. I hope you understand stocks and bonds easily, and develop your own strategies.
Stocks : from ownership to risks
▪️ Ownership
Buying stocks, you own a part of the company. This ownership doesn’t mean just owning stocks. You can participate in company decisions, and if the company makes profits, you can receive dividends. It means you are a part of the company directly.
▪️ Relationship between a company and stockholders
Stockholders are important stakeholders for a company. The company provides transparent company business to stockholders, and is responsible to improve stock value through long-term growth. The stockholders participate in a general meeting to suggest their opinions of the company’s decision making. In this process, the stockholders monitor company’s management and encourage clean business management.
▪️ Importance of Liquidity
Another important characteristic of the stocks is liquidity. Liquidity is how easy it is to convert the stock into cash. There are tons of stock trades in a day, and it means investors can sell the stocks whenever they want to. Because of high liquidity, the investors can secure cash urgently and rearrange their strategy based on market conditions.
▪️ Pros and cons of liquidity
Liquidity doesn’t have just a positive effect. When the market fluctuates a lot, the stock price can be too volatile, and it increases investment risk. Also, extremely high liquidity causes an overheated market, and leads to a market bubble. Therefore, the investors must understand the advantages and disadvantages of liquidity and utilize it based on their investment goals.
▪️ Risks and management methods
Understanding risks of stocks is very important. Volatility of the stock market is severe, and the price goes up and down because of various external factors. The price can plunge if a company’s profit is worse than expected, or the economic situation is getting worse. We consider the following methods to manage the risks.
- Diversification
Diversification is an efficient method to lower investment risks. This strategy decreases influence of a certain part through investing in various sectors, regions, and companies. Each sector and market is affected by different factors, so a loss from one part can be offsetted by a profit of another part.
Diversification helps to maintain the value of assets while the market suffers from uncertainty. Each investment is affected by different economic cycles, and this makes the risks diversified. It contributes to maintaining and stabilizing the return of the portfolio in the long term.
- Long-term investment
Long-term investment is a strategy to invest in the long term while not affected by short-term volatility. The market seems difficult to forecast in the short term, but it might show stable growth in the long term. Long-term investment maximizes compound effect using time and decreases risks from the short term volatility.
Long-term investment also soothes stress stemmed from short-term market volatility and provides long-term asset growth potential at the same time. This is especially ideal for investors who target retirement funds.
- Sustainable market analysis
It is necessary to analyze markets continuously. Analyzing market situation, economic indicators, and company performance, investors can make decisions based on precise information. This helps investors to understand market movements and economic trends, and to rebalance investment strategies.
Sustainable market analysis makes the investors capture risks and opportunities. It contributes to making profound and tactical investment decisions and increases probability of success in the long term.
Roles of stocks : from capital to profits
▪️ Importance of financing capital
Stocks is a tool for companies to finance capital. The companies need a significant amount of capital to grow and expand the business. They issue the stocks to finance capital for those. Issuing stocks, the companies secure capital, and the capital can be used for new projects, R&D, and infrastructure expansion.
Financing capital is especially important in the growth phase of the firms. In an early phase, the firm needs capital to position in the market, and in a growth phase, it needs capital to expand and evolve. Unlike loans, stocks don’t increase the debt of firms, so it maintains financial solvency.
▪️ Role as the market value evaluation
The stock market has an important role to evaluate a firm’s market value. The stock price reflects investors’ opinion about the present and future of the firms’ value. It is a public and transparent method to evaluate the firms’ value, and using this, the investors measure the firms’ growth potential.
The market value not just reflects fiscal performance. Various factors affect the stock price including technology revolution, management strategy, competition in markets, and even social and ecological responsibility. The investors assess the firms in those comprehensive perspectives.
▪️ Opportunities for profit
Stock investment brings opportunities for profits. There are 2 profit sources related to the stock investments ; stock price increase and dividend. The company’s business is successful and the stock price increases, and the investors earn capital gain. Additionally, some companies allocate a dividend to their profits, and this can be a continuous profit source for the investors.
Investment profit sounds attractive, but it also has a close relationship with risks. Investment performance can increase and decrease based on market fluctuation and companies’ performance. Thus, the investors have to approach in the long-term perspective and diversify the risks using various portfolios.
Types of stocks
The stock market comprises various types of stocks. Each stock has its own characteristic and benefit. We will see common stock, preferred stock, growth stock, dividend stock, and value stock.
▪️ Common stock
Common stock is a type of stock we can meet easily. It has a voting right. It means stockholders can directly affect companies’ decision making and policies. Also, it has a dividend right.
The investors investing in common stocks expect stock price increase along with the company growth. However, they also have risks when the company’s performance is getting worse. Therefore, when you invest in common stocks, you have to consider the balance between risks and profits.
▪️ Preferred stock
Preferred stock has an advanced right in a certain condition than the common stocks. Usually, the right is the dividend right. That is, the stockholders receive dividends prior to those who have common stocks. But most preferred stocks don’t have a voting right.
Preferred stocks suit investors who want stable dividend profit. Plus, the stocks have asset allocation priority when the company is bankrupt. On the contrary, the stockholders cannot be beneficiaries from stock price rising.
▪️ Growth stock
Growth stocks are stocks whose value increases fast. Those stocks usually have high profit potential, but also have high risks. Most growth stocks are in tech sectors.
Investing in growth stocks provides an opportunity to take high profit, but you should understand and manage market volatility risks. Therefore, you should focus on the long term perspective.
▪️ Dividend stock
Dividend stocks are stocks providing stable dividend profit. They are issued by fiscally stable companies. They are also appropriate for investors who want low risk and stable profit.
While selecting the dividend stock, you should consider the company’s ability to provide dividend, history, and fiscal solvency. Plus, you ought to consider not just dividend rate but also growth potential.
▪️ Value stock
Value stocks are under-estimated. They show stable profit and adamant financial status, but are traded at a relatively low price. The stocks are proper for investors who seek long term investment value.
Investing in value stocks concentrates on the long term and finding undervalued stocks than intrinsic value. This approach isn’t affected by the short-term fluctuation and seeks long-term stable profit.
Various approaches
There are various types of approaches in stock investment. Each approach can be applied differently based on investment goals, risk preference, and time horizon management. We will see direct investments, fund investments, ETF, and automatic investment systems.
▪️ Direct investment : individual approach
Direct investment is a method to select and buy stocks individually. Investors analyze and research about stocks personally and select which one to invest. The investors should scrutinize a firm’s financial status, management strategy, and industry trend.
Its advantage is that you can take complete control in the investment process. However, it takes lots of time and effort, and also risks.
▪️ Fund investment : advice from experts
Fund investment is a method to invest indirectly in various stocks. In this method, a fund manager selects stocks. It makes investors diversify their stock portfolio and use an expert’s knowledge and experience.
Fund investment brings risk diversification effect through investing in various stocks. Also, it saves time and effort because it uses an expert. However, there is a management fee and you are dependent to the fund manager’s decision.
▪️ ETF investment
EFT is a fund following a certain stock index. ETF investment is useful when you want to follow the market growth. It includes various stocks, so you can expose your portfolio to a vast market in one investment.
EFT has low management fees and high liquidity. Additionally, it seeks average return of the market and has a diversification effect.
▪️ Automatic investment systems
Automatic investment systems like robo-advisors compose your portfolio automatically based on your risk preference. This system analyzes the market data using algorithms and suggests a customized portfolio.
It simplifies investment procedures and saves significant time and effort. It also maintains an objective and consistent investment strategy against emotional decisions.
Bonds : from the definition to investment methods
Bonds are an important asset class like stocks. It is loved by investors because of stable profit and low risk. Before this, you should understand what the bonds are and how the bonds develop. We will explore the definition, history, characteristics, types, and investment methods of bonds.
Understanding of bonds
▪️ Definition and structure of bonds
A bond is a crucial tool. It is a debt certificate of a government or a company to borrow money. Investors lend money during a specific period and receive interest. The largest benefit of the bond is a stable profit and foreseeable investment result. As the bond expires, the investors receive the principal.
▪️ Importance of bonds
The bond can diversify portfolio risks. Unlike volatile assets like a stock, the bond provides a relatively stable return rate and roles as a buffer to protect assets in uncertainty. These characteristics make the bonds an attractive option for investors who seek a long term and stable profit.
▪️ Relationship between bonds and investors
Investing in bonds is based on a promise between an issuer and investors. The issuer pays interest during a specific period and repays principal at maturity. The investors receive foreseeable profit, and the issuer secures necessary capital. This interaction shows bonds’ important position in a financial market.
▪️ Variety of bonds
The bond has various types. Government bonds, corporate bonds, municipal bonds, et cetera are there, and each bond has different features, risk, and profit. That diversity expands investors’ options and makes investors select bonds that are appropriate for their goals and risk preference.
History of bonds
▪️ Origin of bonds
Its origin starts in the ancient era. In the beginning, governments issued bonds for war and national projects. Those early bond types were used to meet the government’s needs and took a great portion of national finance.
▪️ Bonds in middle age
The bond developed in middle age. Countries in Europe issued bonds for wars, expedition, and colony expansion. The bonds in this era are a basic form of bonds we know.
▪️ Bonds and industrial revolution
Corporates issued bonds in the industrial revolution era. The bond made firms fund more capital they needed and expand the business. Appearance of corporate bonds changes financial markets a lot and provides more investment options to investors.
▪️ Bonds in the modern era
When the 20th century started, the bond market became complicated and various. Many types of bonds arose, and while they were connected with international markets, the bonds became important. Also, technology development made bond trading more easy and efficient.
Nowadays, the bond is an important tool for the government, firms, and individual investors. Many investors prefer the bond for its stable profit and low risk, and it is considered as a safe asset in crisis.
Development of financial technology makes the bond market change continuously. Digitalization, automation, and globalization are factors to compose the future of the bond market, and they provide more opportunities and challenges to investors.
Characteristics of bonds
▪️ Stability
The bond has lower risk than the stock. Government bonds and corporate bonds of conglomerates especially have low default risks. The stability is important when the market fluctuates a lot or the economy is uncertain.
The stability of the bond has an important role in the portfolio. It protects assets against stock market volatility and provides consistent profit. Therefore, the bond is appropriate for the long term investment and retirement plan.
▪️ Profitability
The bond provides regular interests. It provides a foreseeable profit and ensures regular cash flow for investors. It is beneficial for investors who want regular income. That’s why another name of the bond is fixed income.
The profitability of the bond can be used for various strategies. For instance, you can reinvest interest income or use it as a regular income. In addition, combining various bonds with various interest rates and maturity, you can rebalance the portfolio based on your investment goals and risk preference.
▪️ Maturity
Every bond has maturity(of course, there is a perpetual bond which doesn’t have maturity). When the bond expires, the investors receive the principal. It means bond investment is easy to expect and plan. The maturity varies from short to long term, and this provides options to choose based on the goals and situations.
The maturity can be used differently. For example, if you need capital on a specific day, you can buy a bond which has maturity on that day. Also, including bonds with different maturities in the portfolio, you can diversify the risk and manage cash flow.
Types of bonds
▪️ Government bond
Government bond is a bond issued by the government, and has the lowest risk among bonds. It is based on the government credit rate, so its default risk is very low. Investors prefer the government bond because of stability.
The government bond is used for public projects and running the nation. It provides stable but low profit and is considered as a safe asset in uncertainty.
▪️ Corporate bond
The corporate bond is issued by companies, and has a higher interest rate than the government bond. But it has a higher risk. Its risk is based on the company’s financial status and market position.
The corporate bond provides higher profit. Investors make investment decisions evaluating the company’s growth potential and fiscal solvency. It has a significant role while constructing portfolio.
▪️ Municipal bond
The municipal bond is issued by local governments or public institutions. It is used for local public projects or infrastructure development. It has a higher risk than the government bond but still provides a stable investment option.
The municipal bond provides opportunities to contribute to developing the local community. It directly affects local community development and makes stable profit at the same time.
▪️ Investment grade bond
The investment grade bond has a high credit rate and low default risk. It is issued by fiscally stable companies or the government. It is proper to investors who want to minimize risks and seek stable profit.
It is also attractive to investors who expect a certain profit while avoiding risks. This bond is based on the strong credit rate of economically stable firms and the government.
▪️ Speculative grade bond
The speculative grade bond, also known as a junk bond, has lower credit rate and higher interest rate. It provides a very high return for investors who are ready to take high risks. However, its default risk is really high, so you need to scrutinize carefully before investing.
To invest in the junk bond can be a good strategy to seek a high return and manage risks. Investors have to evaluate potential risks and profit sophisticatedly and make a decision whether it fits to goals and risk tolerance.
Investment methods
▪️ Direct investment
Direct investment is a method that an individual investor selects and buys the bond directly. In this method, the investor has to understand enough about the market situation and characteristics of the bond. It gives full control but also requires market knowledge and analysis skills.
The advantage is that the investor can select the bond based on the goal and risk preference. But it takes lots of time and effort to select, and the investor has to consider the risk.
▪️ Fund
Like the stock, the bond has a fund. Of course, a fund manager selects and manages the bond. It provides an opportunity to access bonds easily, and the investor can use the knowledge and experience of the expert.
Plus, it provides a risk diversification effect. Investing in various bonds in one fund, the investor takes lower overall risk than investing in a single bond. Additionally, the fund manager can rearrange the fund according to the market situation and movements.
▪️ ETF
EFT can be composed with bonds. It is traded in the stock market, so it has high liquidity.
ETF has low management fees and high liquidity. Like the stock ETF, it is easy to access, so it provides opportunities to participate in the bond market efficiently.
The stock and bond are its unique advantage and risk, and provide balance and diversity to the portfolio. The stock investment seeks a high return participating in the company growth, but the bond investment is a safety net against economic volatility with a low risk and stable profit. It is necessary to combine those 2 asset classes to achieve the long term financial goal and manage risks. The investor must combine them properly considering risk preference, profit expectation, and investment horizon. It is the first step to succeed in investment, and I hope you make your own strategy based on your goals.
