Bonds vs Stocks vs Funds

Parking your money in a regular savings account is never a good idea. Warren Buffet, one of the world’s most successful investor of our time has this to say about investing in cash:

The one thing I will tell you is the worst investment you can have is cash. Everybody is talking about cash being king and all that sort of thing. Cash is going to become worth less over time… Cash is a bad investment over time.”

The purchasing power of your money falls every year because of inflation. No matter how much money you put in your savings account it will never be enough since prices of goods and services will continue to rise. Don’t just save. Invest. You need to start investing in something that will give you a higher return. But before you start investing, you have to make sure if you are ready to invest first.

If you are ready, there are tons of investment vehicles to choose from. The most common for long-term investments that requires little capital are bonds, funds and stocks.

Bonds

A bond is a debt investment. In Filipino, we call it ‘pautang’. Instead of borrowing money from the bank, the government or a corporation sells bonds to investors to raise money. You as an investor will lend your money for a fixed interest rate at a given period of time. In short, you become a lender. The borrower in turn pays you regular interests until the term ends.

Although riskier than cash, bonds are less risky compared to funds and stocks. If you lend your money to a friend, you are not sure if your friend has the capability to pay you back. In bonds however, there are agencies like Standard & Poor’s, Moody’s and Fitch that gives credit rating to governments and businesses. The credit rating estimates the ability of an organization to fulfill its debt obligation.

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 The higher the credit rating is, the lesser the chance of default.

Image Source:  Neighbourly

As an investor you are looking for a high credit rating. A high credit rating indicates a sound economic management by a sovereign or business. An AAA rating means excellence while a C or worse a D means poor. When the Philippines’ credit rating went several notches higher during the Aquino administration, it showed investors that the Philippines has a strong capability to pay its debts prompting foreign investments into the country.

If you are going to invest in bonds, you need to familiarize yourself with the following terms:

  • Face Value – the value of the bond including the principal and the interest once the term ends
  • Maturity – termination date or the day you can have your money back
  • Coupon Rate – the interest rate
  • Coupon Dates – dates when the interests will be paid
  • Issue Price – principal or the original amount you lend

Bonds are recommended for conservative investors.

Stocks

Owning a business entails a lot of work especially if you build your business from scratch. You need to oversee not just the day-to-day operations but also other aspects like marketing, human resource and financial management. You may be your own boss but you have a lot of responsibility. You need to make tough decisions and sometimes work long hours.

Investing in stocks is just like owning a business. The only difference is that you don’t need to go to work at all. You can just sit back, relax, wait for your pay check and let the likes of Bill Gates, Jack Ma, Warren Buffet or Jeff Bezos take care of your money. In the Philippines, you can let the Ayalas, Sys, Gokongweis, Tans and all other business tycoons in the county worry about the day-to-day operations of the business while you just wait for your income. Now, how cool is that?!

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With stock ownership, you can just watch the company grow without lifting a finger yet still get paid with dividends.

A stock means a share in a company. As part-owner of a company, you get a claim on the company’s assets and earnings. You cannot make decisions on the management of the company though. As a common shareholder, you do however have the right to vote on major issues such as changes in charter or board of directors during shareholder’s meeting.

There are two possible ways to earn money from stock ownership. One is through price appreciation.

For example, if you have bought a share of Facebook when it was first offered to the public at US$38 per share way back 2012; your US$38 investment as of the time of this writing now cost US$164 dollars per share. In the Philippine setting, if you have bought a stock of Double Dragon Properties Corp., the property firm of Jollibee and Mang Inasal, when it was first offered way back 2014 at two pesos (P2) per share; you would have seen your investment grew by 4,000 percent (yes, you read it correctly), when it reached its all time high of P80/share only after two years. That means if you have invested P5,000 then, your investment would have had a value of P200,000 in two years time. Please take note that earnings on capital appreciation remain as unrealised gains until you have actually sold the stock.

Another way to earn through stock investing is through dividends. A dividend is a payout given to shareholders. It is your share of the company’s earning. The more shares you own, the larger your share is with the company’s profits.

Stock investing however is only recommended for the aggressive investors or investors with a high risk tolerance. There are no guarantees when it comes to individual stocks. The market is very volatile. Since there are more risks involved, the rate of return is also higher compared to other investment vehicles. Historically, investing in quality stocks or blue chips companies have outperformed all other asset classes.

To start investing in the stock market, you need to open an account with an online stock broker. The minimum initial investment required to open an account is five thousand pesos (P5,000).

As a precaution, you should not invest all of your money in stocks. The general rule for computing the maximum allowable investment in stocks is 100 minus your age. For instance, if you are 45 years old, 100 – 45 = 55. Therefore, invests only 55% of your money in the stock market. Put the remaining 45% on other safer investment vehicles.

Mutual Funds

If you want a higher return but without the complications of understanding financial statements, the stock market and the economy as a whole; then a mutual fund is the investment vehicle for you. A mutual fund is a pool of money from several investors. It is managed by professional money managers. The fund manager will collect all the money and invest them in diversified holdings such as stocks, bonds and other securities.

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A mutual fund is a pool of money invested in different asset classes by a professional money manager.

The government regulates the funds so the fund managers cannot just take your money away and hide it in a remote island somewhere. In addition, you can have investments in multiple investment vehicles or companies even with just a little amount of money. In the Philippines, the minimum starting requirement is just five thousand pesos (P5,000) roughly about US$100. Minimum additional placements or investments is just one thousand pesos (P1,000) or about US$20.

There are many different kinds of funds to choose from depending on your financial goals and risk tolerance. There are funds that offer a mixture of bonds and funds for those who are moderate investors.

The main disadvantage of mutual funds is that because it is being handled by a professional manager, mutual funds charge management fees such as sales commissions, transaction costs and redemption fees. Also, just like bonds, mutual funds have a holding period. You cannot take advantage of short term rise in the market because you are not allowed to withdraw your money anytime you want to.

Happy investing!

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