Why invest in financial instruments?
You have to invest in financial instruments.
Why?
Now we see it.
First of all, why do people invest?
To increase the capital over time, but above all not to lose it.
I think you know it, but central banks are aiming for 2% inflation to keep the economy enticed to grow.
Why 2% and not 30%? It should grow faster, right?
Would you work if you knew that a third of your salary would disappear at the end of the year?
Not me.
So why not negative, so we would all earn …
Would you work if you knew your money generates wealth automatically?
Again, not me.
We now know that on average, remember on average, our capital loses 2% of value per year.
(With the inflation of 2022 also a 7-9%)
Why invest in a financial instruments?
We have arrived at the title of today's page.
Let's see what a financial product is.
As I have already advised you, Investopedia is the solution to everything:
"Financial instruments are assets that can be traded, or they can also be seen as packages of capital that may be traded"
Financial instruments allow you to have access to assets that are very liquid (the market tends to be open 8 hours a day, 250 days a year and the buyers are always there) and geographically diversifiable and correlated between asset classes.
We will see what correlation is when we understand how to build a portfolio.
Financial Products
Let's see a list of financial products.
I will try to analyze them one by one to understand if we can use them to reach our goal:
Stocks
From Wikipedia:
"The stock (also capital stock) of a corporation constitutes the equity stock of its owners. It represents the residual assets of the company that would be due to stockholders after discharge of all senior claims such as secured and unsecured debt."
Buying stock in a company is buying part of a company without managing it.
So, at the end of the year, profits (or losses) are divided with you.
You will never be asked to add additional capital to the one already spent on the shares you bought, but their value could go up / down due to the financial situation of the company. Dividends, however, will be recognized to you
Pros:
You own a business
You gain the profit (in some case)
You don't have to run the business
Cons:
Market fluctuation
You bear the losses (in some case)
The best companies often have high prices to discourage speculation
You often have no say in business decisions
You are affected by the specific risk of the company (Don't worry we will look at the various types of risks next time, trust me)
Company may close and your capital is lost
Bonds:
From wikipedia:
“A bond is an instrument of indebtedness of the bond issuer to the holders.”
Buying bonds gives you the right to receive periodic payments (coupon) from the bond issuer and a final repayment at expiration date. If you bring the bonds to maturity, absolutely nothing will change for you, while if you want to sell it first its value will change as the situation of the debtor, interest rates and other variables change.
There are both government and corporate bonds.
Pros:
You are entitled to pre-determined payments
Profit is sure
Cons:
Market variables more difficult to foresee
To receive higher returns you have to invest in more risky bonds
During the last years "secure bonds" gave 0 or negative earnings
You are affected by the specific risk of the country/company
Funds
We will see them in next posts.
Futures, Swaps, Options and Forward contracts, currencies, Forex
They are more complex financial products that require a lot of preparation to be used used in order not to create problems to the owner. Suffice it to say that they are difficult to maintain over the long term due to higher associated risks.
They are not useful for our purpose, even if they may affects partially our financial results.
Site tips:
Investopedia as always