Is a pick-up a better vehicle than a Lamborghini? Well, it depends on the situation…if you are stuck in the mud, the four wheel drive F-150 will be the best choice. If you are heading to reach maximum speed maybe you should try with a F1 car, if you want security you could buy a Volvo, if you don’t know how to drive you should definitely travel by bus and…and…..OK, OK, enough examples!

What I mean is that an investment vehicle is like any other vehicle, it is a tool that helps to reach a predifined goal at a specified time. So the important things to consider in any endeavor are: having a goal and having knowledge of how to use the resources available to reach that goal.

The great investor Warren Buffett often says “I invest in businesses that I understand”.

The following are the six basic types of investments. I strongly recommend you to learn everything you can about these financial instruments, for it is certain that any investing activity you’ll undertake will be involved with one or more of these types of investing vehicles, directly or indirectly.

1 - MONEY MARKET (very conservative):

• Very liquid markets (short-term debt).
• Little or no risk (unless you lived in Argentina in 2001!). Very low reward, usually lower than inflation.
• Individual investors can access these fixed-income securities through mutual funds (see below) or Certificates of Deposit (”plazo fijo”).
• When I don’t know what to do with my money or while deciding where to invest it, I usually put the money in a money market. Your money should be always working for you!
• Level of difficulty: very easy.
• How do you invest in Money Markets? Contact any bank or investment firm.

2 - BONDS (conservative to aggressive):

• Bonds are a type of debt that is commercialized to the public through the open market and trades as a security. You are the creditor, and as such, you receive an interest on the money you invest.
• Low volatility -> Low risk/return.
• Current market price: sensitive to the macro situation of the country/region. If you plan to invest in a bond until maturity the price fluctuations don’t matter.
• Principal: the capital initially invested.
• Coupons: regular cash payments. It is the interest returned on the capital borrowed.
• Maturity: the time when the bond has completely repaid the principal plus the interest (coupons) and ceases to exist. *Duration: it is a measure of the interest-rate risk/reward for bond prices, expressed in years. Useful to objectively compare different bonds. Short-term bonds have maturities of less than 2 years. Long-term bonds have maturities longer than 10 years.
• Types of bonds depending on the issuer: Government bonds, municipal bonds, corporate bonds.
• Types of bonds depending on the return: fixed return, inflation adjusted bonds, investment grade (low risk/return), junk bonds (higher yields and higher risk).
• Yield: it is the annual rate of return for any investment, expressed as a percentage. Used to measure the performance of bonds.
• Treasuries: US Government Treasury bills are officially the safest investments in the world, and the 10 year T-note’s yield is a regarded as the risk-free rate.
• Bonds are anti-cyclical: the price(yield) of bonds rises(falls) on recessions. The price(yield) falls(rises) on inflationary periods (because inflation eats out bonds nominal returns).
• Wenn Sie mit anderen Spielern an einem offentlichen oder reservierten Tisch everest poker m?chten, w?hlen Sie Multiplayer aus. Not suitable for trading: trading in bonds require large amounts of capital. Used individually as a conservative investment.
• The king of bonds: Bill Gross from PIMCO is the money manager of the largest bond fund.
• компютри втора употреба Bonds ETFs symbols to trade bonds like stocks (for more info on ETFs see below): AAG,SHY,TLT,TIP.
• Level of difficulty: a bit difficult. Requires some knowledge of economics.
• How do you invest in Bonds? You have to open an account in an investment bank or a broker.

For more info on bonds visit http://www.pimco.com/LeftNav/Bond+Basics/2006/Everything+You+Need+to+Know+About+Bonds.htm

3 - STOCKS (moderate to very aggressive):

• Companies can raise money by offering stocks to the market. You own a part of the company, so as a partner you are in for the upside…and for the downside.
• Buying stocks for capital appreciation: the price of a stock is basically derived from the expectations of future earnings of the company.
• Buying stocks for dividends: a way to obtain cashflow from your investment in stocks. Some companies pay dividends, these are often called “value” stocks. “Growth” stocks usually don’t pay dividends, they reinvest earnings.
• Level of difficulty: difficult. You should know about the economy and how the stock market works, also you should know a bit about the industry and finally you should understand how to read ratios and financial statements: income statement, balance sheet, cashflow statement. Of course….can you start investing in stocks without knowing some or all of these things? Yes! But start with little money because at first you won’t know what’s going on.
• How do you invest in Stocks? You have to open an account in a stock broker.

4 - REAL ESTATE - PROPERTY (conservative):

• First of all: I’m NOT talking about your house (the one in which you live). Your house shouldn’t be treated as an investment, and neither your car. What I’m talking about here is using properties as investment vehicles.
• You can buy property for one or two objectives: capital appreciation and/or cashflow (renting).
• Leverage: if you can’t (or you don’t want to) buy the property with cash, you can always apply for a mortgage. This is very important because this is the only investing asset in which you can borrow money relatively easy and with a reasonable interest rate. Using leverage by borrowing money increases dramatically the rate of returns (or losses) of any investment.
• The real estate market is very inefficient compared with the stock market, but there are more opportunities to negotiate and obtain an interesting entry price.

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• High costs of transaction, very illiquid assets (these are long term investments).
• Level of difficulty: very difficult. These are no small deals, and you should be well educated before starting to invest in properties.
• How do you invest in Property? You should contact a Real Estate agent or broker specialised in properties as investments.

5 - BUSINESSES AND START-UPS - Private Equity funds, Venture Capital (very aggressive):

• For professional investors, usually large investment firms/banks.
• Investing clubs: a group of individual investors raising a pool to invest in start-ups.
• Level of difficulty: very difficult. You need to know perfectly the things I described before in stock investing, and moreover you should be experienced in management.
• How do you invest in Companies? There are investing clubs specialised in venture capital. Another way of investing in businesses is franchising.

6 - COMMODITIES - Precious Metals, Basic Agriculture Products, Basic Mining Products (very aggressive):

• More suitable for trading than investing.
• Trading via Futures (see below) and now also through ETFs: GLD,SLV,USO,UCR…
• Level of difficulty: difficult. Commodities prices are very volatile, you need to know about the actual commodity you trade: how it is obtained and distributed, seasonal patterns, global markets, etc.
• How do you invest in Commodities? You have to open an account in a stock broker and ask to trade futures.

When you have learned the characteristics of a financial vehicle you are better prepared for:

1. evaluating current conditions to see whether this is the proper time to use this asset
2. knowing how to use it and
3. assessing what are the risks and rewards associated, and how to handle them to maximize the probabilities of success.

In a next post I’ll cover the most common indirect investing vehicles like mutual funds and retirement funds. All of them are based on the basic tools described here.

Every decision we make has its advantages and disadvantages, we never hit it right on the target, but we keep trying to learn how to miss by the least.

So every-time since we wake up in the morning we are faced with lots of choices. Some of those decisions are made mechanically, intuitively, some others need a cost/benefit analysis.

Investments are no different from everyday decisions. When we are taking investment decisions we need to analyze risk and reward. But we often forget about the former, and only concentrate on the later. If you take a look at financial instruments like mutual funds, stocks and bonds you’ll have little trouble finding the expected return those investments offer. But it won’t be as easy if you try to find the risks associated with those investments.

We need to quantify risk as well as we quantify return:

While mutual funds provide precise return numbers, most risk disclosures are still vague at best. For example, most mutual funds convey their proclivity for assuming risk with only generic labels like, “aggressive,” “balanced,” or “moderate”. Risk should be quantified as rigorously as returns. How would you feel if your mutual fund statements reported that your last quarter’s returns as “conservative” or “moderate”, instead of stating the actual return number?

Briefing.com

But the problem with risk is that there isn’t a simple magic number to measure it. Properly assessing risk is more an art than a science, let’s find out why.

Elements of risk

There is a huge list of risks in every activity we do daily, although most of those risks are so familiar to us that we don’t even remember or take care of them (i.e. crossing the street, driving, etc.). But what is risk after all? What is risky for you isn’t necessarily risky for others. So we need to know how to measure risk in a specific way that anybody can interpret without misunderstandings. The two basic facts that define the relevance of any risk are:

• Probability: risk probability assessment investigates the likelihood that each specific risk will occur.
• Impact: risk impact assessment investigates the potential effect a risk can take if it occurs (the size of the potential loss).

For instance, the impact of an airplane crash means almost always death, whereas a bus accident not necessarily ends up in a complete tragedy. But the probability of an airplane crash is almost zero so the overall risk of flying is a lot lower than the risk of driving or travelling by bus.

Volatility and Risk

The standard deviation of the price of an asset (also known as “volatility”) indicates the potential size of losses or profits it can give as an investment. Volatility is usually mentioned as a synonym for risk.

One of the most biggest mistakes in my opinion is the common notion of volatility as a synonym for risk. Investments are categorized as more risky or less risky by their volatility, but as I have said before, volatility indicates the potential size of losses….or profits! Volatility is not necessarily a bad thing, it can be indeed a great factor.

We tend to put more stress on impact than we put on probability, usually because of fear caused by not knowing about the subject. To achieve an acceptable estimate of the probability of an event you must develop knowledge and experience. Then when you are experienced you are willing to take more risks…controlled risks (low probability, higher volatility) to expand your returns without increasing your overall risk.

Risk response strategies

Planned risk responses must be appropriate to the significance of the risk, the plan must address the risks by their priority. These strategies typically deal with threats or risks that may have negative impacts on your objectives, if they occur:

• Avoid: this strategy involves changing the plan to eliminate the threat posed by an adverse risk. Some risks that arise early can be avoided by obtaining information and/or acquiring expertise.
• Transfer: risk transference requires shifting the negative impact of a threat, along with ownership of the response, to a third party. One of the most common transference tools is the use of insurance. In the case of stocks, you can limit your downside risk by buying put options of the stocks you own.
• Mitigate: risk mitigation implies a reduction in the probability and/or impact of an adverse risk event to an acceptable threshold. This strategy can be achieved in investment activities like real estate or your own business. In bonds, stocks and commodities it is almost impossible to mitigate risks because the factors affecting these kind of assets are out of our control.
• Acceptance: sometimes there is no response strategy available or the cost of dealing with the risk is greater than the risk itself. In that cases you must establish a contingent reserve to handle known/unknown threats. For example it is not recommended to sell a stock on every minor pullback if you are investing for a longer term, since the costs of commissions and slippage can eat your return.

Contingent response strategy: the probability and/or impact of some risks justify the design of a response plan, these plans are used only if certain events occur and these events should be defined and tracked. For example always before you buy a stock you should already have a plan for the entry (entry price), to sell at a profit (profit target) and to sell at a loss (stop loss) if the price goes against you.

Common investing risks and strategies

There are several types of risk you need to analyze, but a top down basic list would be: Global risk, Country risk, Sector/Industry risk, Company risk.

• Global risk is related with the macroeconomic situation globally and how it affects the markets. It includes interest rates, GDP growth, currencies, commodities, etc.
• Country risk is related with the macroeconomic situation locally. It also includes the former subjects, but from a local perspective.
• Industry risk deals with the situation of a sector or industry within a single country. For instance the current internal conditions of the real estate industry in the US aren’t as healthy as other industries like oil related industries.
• Company risk is involved in the risks inherent to a particular company. It is concerned with the degree of debt the company has incurred into, the revenues/profits forecast, the cash-flow prospects, the skills of the management team, etc.

Several known strategies have emerged to treat market risk properly. The more important are:

• Diversification: you can minimize risk by spreading your investments, and avoiding an over-concentration in any single company, industry, or country. Studies show that reasonable diversification can be achieved with as little as a dozen stocks. Moreover since the becoming of ETFs (Exchange Traded Funds) diversification is easier than ever to achieve. You should also diversify among different investments like stocks, bonds, options, futures, real estate, businesses, etc.
• Money management: this is one of the most important concepts of all in investing. It is impossible for you to win every-time you trade so you have to allocate a limited amount of money to any particular position. Professional money managers don’t risk more than 1% of their accounts in a single trade. If you always invest all you have got in one bet you are putting yourself in a very difficult situation, because at some time you will be wrong and you will lose all your money.

Summing it all up

I think the worst risk of all is ourselves. Many people believe investing is risky, but when you become more knowledgeable in investing you realize that WE are the ones who are risky! Ignorance and lack of information make us risky.

Usually, people let others decide what to do with their hard earned money. The problem is we almost always seek advice from salespeople, not rich people. Most stockbrokers are not rich nor do they invest in what they sell. There’s a famous quote from Warren Buffett (the most successful investor of our time) that says:

Wall Street is the only place that people ride to in a Rolls Royce to get advice from those who take the subway.

To learn how to make bread you should ask a baker. To learn how to invest successfully you should study the lives of the pros, reading/watching their biographies and getting to know how they make decisions and how they think.

Risks are moving targets, what is not risky today might be risky tomorrow. The best way to treat risks is by learning how to identify and measure them, and by making plans to defend ourselves from those events whether they occur.

We can’t expect to get anywhere if we avoid taking risk. History shows that great accomplishments have always involved taking significant calculated risks in one form or another.

Rather than avoid risk entirely, avoid taking poorly understood risks. Take risk only when the upside justifies the downside. The ability to understand and measure risk will empower you to make better investment decisions.

Usually when we talk about the stock market people say “the stock market is pure luck, it’s like a casino, there’s no way to make money out there…”. I used to have difficulties explaining the differences I found between the stock market and casinos until I read “Come into my trading room” from Alexander Elder. The following is an excerpt from the book:

Most people gamble at some point in their lives. For most it provides entertainment, for some it becomes an addiction, while a few become pros and make a living at it. Gambling provides a living for a very small minority and entertainment for the masses, but a casual gambler reaching for a quick buck has the same chance of success as an ice cube on a hot stove.
Some card games, such as baccarat, are based on chance alone, whereas others such as blackjack, involve a degree of skill that attracts intelligent people. Professionals treat gambling as a job. They keep calculating odds and act only when mathematics point in their favor. Losers, on the other hand, itch for the action and enter one game after another, switching between half-baked systems.

Trading is the most exciting activity that a person can do with
their clothes on. Trouble is, you cannot feel excited and make money at the same time. Think of a casino, where amateurs celebrate over free drinks, while professional card-counters coldly play game after game, folding most of the time, and pressing their advantage when the card count gives them a slight edge over the house.

So the answer to the title is YES! The stock market is very much like a casino, because the vast majority of ignorant individuals get bust trying to make some easy money. “The house” (the major brokers, the “market makers”) eat them alive. Yes, it is very difficult to consistently beat the market as an individual trader, for instance take a look at the large investment institutions: they have a ton of analysts and traders who work every single day trying to find the best opportunities. And a lot of them fail too, so what’s left for us?!

Anyone can make money on a single trade or even several trades. Even in the casinos of Las Vegas you continuously hear the music of the jackpots. Coins pour from the slot machines, making a happy noise, but how many players go back to their rooms with more money than they came with? In the markets, almost anyone can make a goodtrade, but few can grow equity.

To be a successful trader, you have to develop iron discipline (Mind), acquire an edge over the markets (Method), and control risks in your trading account (Money).

The next posts on this subject will be about trading psychology, trading systems, and money management, which are the tools we need to master in order to be successful in trading.

But there’s a big difference between the stock market and a casino game. Casino games were made to make it almost impossible to beat the house, anyway there are a few systems for getting an edge on some of those games like the roulette and blackjack. Some skilled people happened to master those complicated systems, they broke the bank in casinos all over the world until they weren’t allowed to enter one any more, no more casinos let them play.

One of my favorite clients is a professional trader in London who
sometimes, for entertainment, goes to a casino at night. He plays
blackjack for a minimum stake of £5 and quits when he is either £200
ahead or £400 behind. He has worked out a card-counting method
and a money management system that have him going home with £200
13 times out of 14. He has proven to himself that he can steadily win
at the casino, and now he rarely goes there because he must spend
6 or 7 hours counting and betting before reaching his winning or losing
limit. It is hard work, counting all the time. The crowd of amateurs
around him is having a lot of fun losing. My client prefers to stay home
and trade stocks where the odds are much more to his liking.

The stock market is a very complex environment with countless variables, but at the same time there are a lot of systems, usually easier to follow, and the probabilities of success are way beyond those of the casino games systems.

Stock trading is not for everybody, it is a complex profession and it has nothing to do with gambling. It takes years of study, preparation and practice. The good news is Internet has made it possible for people like you and me to start with little money, open an account in a discount web broker, get all the relevant information for free most of the time. So the only thing you need at the beginning is time to learn, and to practice “paper trading” (trading in simulation platforms).

Are you ready?

Nobody protects you anymore. In the past years there has been a lot of cases of underfunded pension plans in the USA, some of them resulted in bankruptcies, some of them were severely reduced. Companies are abandoning corporate-funded pensions in favor of defined-contribution plans such as 401(k)s, in which employees make contributions. The conclusion is you’ll have to take care of yourself because it is likely your company won’t do that for you anymore. The State won’t protect you either: the Pension Benefit Guaranty Corp (which insures traditional pension plans) is deeply in the red (23 billion deficit as of 2005) and they are saying “we clearly do not have the ability over the long run to honor all the obligations we’ve taken on”. Maintaining your current lifestyle when you retire will depend solely on your savings and how you invest them.

In Argentina we’re having the same problem, only worse. The amount in commisions we pay to the local pension plans are among the highest in the world. We’re going to talk further about this topic in another post.

To control where your money goes. If you have an illness you do research and consult more than one doctor, if you were in jail maybe you would study law to learn how to handle your case better or to know if your attorney is doing well. And when it turns to the destination you give to your hard earned money, it should be the same.

Time is money, money is time. Start spending some spare time learning finance concepts. All the information you need is on the web, almost always for free! It’s not sky-rocket science, and it is an effort that can change your life completely for good. If you don’t do it for yourself, do it for your kids so you can give them a new world of opportunities. And maybe (as a lot of people like me) you find you’re keen on this topic!

To learn how the world works. It’s a capitalist world. Whether you like it or not we live in a world where the best way to gain full control of our lives is by inventing and maintaining our own cash machine that pays for our lifestyle. Imagine the value of knowing objectively how the country/ industry/company where you work is doing (if it’s doing well or if it’s having problems). And when a recession/crisis comes (they always come once in a while) you will be better prepared to defend yourself, or even have a strategy to take advantage of it.

To put your money to work for you. If you can save $5,000 a year and invest that amount to obtain a 10% rate annually on average during the next 12 years, you will make more than $100,000 by then (provided you reinvest all that money every year). And if you keep doing that for only 5 more years you would have doubled that amount! That is the power of compound interest. So the sooner you start, the better.

To achieve financial independence. Financial independence means not having to work for money anymore. For almost everybody that means being rich. The usual definition for someone who is rich is: “this person has/makes a lot of money”. But as Rich Dad author Robert Kiyosaki says: “It’s not about how much money you can make. It is about how much money you can save, how hard your money works for you and how many years you can live with the income.” So you don’t have to be a millionaire to reach financial freedom, it depends on your lifestyle level and sofistication. We’re going to talk about Kiyosaki’s controversial philosophies in this blog.