We have seen in the previous chapter that there are more suitable products to apply savings, besides term deposits, savings accounts, state certificates or treasury bills (T-Bill). These products tend to follow short-term interest rates, and because they have a guaranteed capital or return, they have meagre rates. Today, in most European countries, finding a 1% rate is already a challenge.
When we talk about investment products, we refer to financial products like shares (which are fractions from an enterprise's capital). It also includes bonds (which constitute the debt of a state or a company) and investment funds (mutual funds) that can invest in shares, bonds and other products – it can also be mixed with shares and bonds.
The ETFs - Exchange-traded Funds – are like an investment fund, but only traded like shares on the stock exchange. There are other products, more complex, like derivatives, options or warrants, and so on, but we will not speak about it here.
How much is my money worth?
It depends on how you deal with it. If you leave 10,000 euros in a term deposit (short-term saving product) for ten years, at the annual interest rate of 1%, you will sum up to 11,046 euros (interest paid once a year). A gain of 1,046 euros.
If you invest it in a long-term product, like an investment fund with a balanced strategy (about 50% shares/50% bonds, but with variations over-time), it gives an annual rate of return of 5%, you could have a very different result. After ten years, the same 10 thousand euros would now be worth 16,289 euros (gross income, we are not including taxes payable). We are, therefore, talking about a difference of 5,243 euros. Almost 47.5% more than in short-term products. This example is based on current market data.
Please note that in investment funds, there is no guarantee of any outcome. However, the results of this type of investment have been categorical. Academic studies like the "Equity Premium Around the World)" paper authored by E. Dimson, P. Marsh, and M. Stanton (2011), from the London Business School, which shows the market analysis of 19 developed countries from the last 111 years — Yes, 111 years (1900 to 2011)! — demonstrates that:
"Since US prices rose 26-fold over this period, it is more helpful to compare returns in real terms (discounting inflation). Over the 111 years, an initial investment of $1 in equities (with dividends reinvested), would have grown in purchasing power by 851 times. The corresponding multiples for bonds and bills are 7.5 and 2.9 times the initial investment, respectively. It corresponds to annualised real returns of 6.3% on equities, 1.8% on bonds, and 1.0% on bills", concludes the study.
In other markets, the hierarchy of conclusions remains, being even more unfavourable for short-term bills: "investments for the long term gives best results". So, does it mean it's all a bed of roses? What about the thorns? Correct, it is not 100% secure. There is a risk, and so you can lose money. But there are also rules and strategies to decrease that risk.
Don't like to carry risks?
Obtaining a significant result, above the short-term rates, without carrying any risk, is the perfect scenario. But a setup like this does not exist! Hence, our suggestion is: whenever a financial trader promises you extraordinary results every year or in the short-term, stay leery. The probability of it being a lie or a fraud is almost 100% certain. Contact the consumer association of your residence, a finance expert or report to the regulator of the sector in your country to receive proper advice.
How to reduce investment risk
There is a risk of losing everything if you solely bet on one title or very few. When companies go bankrupt, for example, you do not recuperate any of that investment. Buying one or two shares cannot be considered a good investment. It is more perilous than anything else because the risks are incredibly high. Investing in cryptocurrencies (such as Bitcoin or Ethereum) is also very risky. Coins are virtual and are not warranted by anything - there is no good they refer to other than themselves (hence the massive price changes). It is only speculation.
Do you know the expression "do not lay all eggs in the same basket"? Invest in several titles! Diversification is the watchword!
Our risk/return studies point to a minimum of 8 to 12 shares to form a portfolio considered diversified. With the costs associated, the portfolio should have at least 25,000 euros if using online intermediaries. And if you want to speculate, we recommend that you do up to 5%, maximum, of your financial assets (excluding non-financial assets such as real estate, for example).
Price and interest rates
Investing in shares and bonds entails various risks of loss of capital, such as changes in prices. Other factors can determine the value of shares and bonds, we will not address all the elements now, but we offer an example for each type of securities. One of the issues that disturb the evolution of shares is the expectation of the company's results. Look at Tesla, for instance, although it has never achieved a profit in a full year of activity, the company continues to worth it because investors keep trusting in its business model and its future results. But every time there's bad news, the title value reacts negatively for a while.
Bonds are susceptible to interest rate changes. If issued in the past with a 5% annual interest rate and if there is a market decline in the interest rate – the current rate in Europe is between negative, and 1% - investors will look for older securities because its periodic interest returns remain high.
As demand increases, the price of old bonds will go up until the real recover they offer to the investor gets closer to the new securities release. In both shares and bonds cases, if you don't have the endurance to wait and sell in a less favourable period, you may lose money. That's the reason why long-term investment is recommended.
We contemplate the "long-term" as a minimum of five years. But bear in mind that it can be more. To give you an idea, in the Crisis of 1929, American stock market investors waited 20 years to watch the index rebound to values before the crisis. Are we in the same situation because of the Covid-19 pandemic? All recent events indicate that most economic impacts will be felt in 2021.
The stock markets fell in all world markets in March this year. But many have regained much of the fall, and others even surpassed it. In August 2020, the S&P 500 index, one of the most important in the US stock exchange, hit the record and reached its highest point ever. It took only 126 sessions to recover from the previous higher value obtained on February 19, 2020. Consequently, those who panicked in March and sold everything paid a very high price. By "alighting from the train", they lost all the market recovery.
Know that by investing in the long-term does not imply that you can allocate an amount in a product and leave it there by itself. If that's what you do, you are committing a big mistake. By putting the money to work for you also mean to watch this "work" from close, especially when global news comes up in the mainstream media. The economic and financial worlds are very sensitive to worldwide news. What happens in the world impacts most of the financial products.
Time and some knowledge
As already mentioned, if you opt to invest directly (without a broker) you must regularly follow your investment, we would say almost daily. Yet if you have no time or knowledge, choose to invest indirectly in equity and bond funds.
If you prefer, you can opt for one or several mixed funds (which hold shares and bonds). And if you want to take advantage of the growth of several regions of the world you can choose funds. They represent an increased cost but allow it to diversify worldwide in the stock market and the bond market. If you need counselling for your decisions, see the recommendations and tips of Euroconsumers Invest Team Network.
You can start with small amounts
We have already mentioned the minimum of direct investment, but if you do not have a few thousand euros to start with, do not despair. The markets are, nowadays, within reach of everyone. You can choose to invest in investment funds from any value. We urge it to be based on mixed funds or very diverse funds. It has products that start with a single stake, which is the minimum unit that you can buy from a fund (the investment fund - Mutual Fund - is like a big money cake, in which each unit of participation is the slice in which it is distributed). Just a few tens or hundreds of euros are enough to start. It is an excellent way to provide a savings investment for your youngsters.
If you have young kids and want to set up a reserve so that they can go to university or take an Interrail throughout Europe or another part of the world), talk to your financial intermediary, subscribe to a mixed fund and schedule a monthly transfer for that objective. It can be 50 or 100 euros, whatever you can and will. Afterwards, if your child is three years old and the goal is to have some money available when he reaches 18, the time horizon is 15 years, a long-term investment!
What's the best timing to "dig in" the stock markets?
There is no correct timing to start investing in the stock marketplace. Several studies show that the most consistent way of getting results is to invest systematically and periodically without taking into consideration whether the market is "bull" (rise of the price of the shares) or "bear" (declining of the values). It's almost impossible to guess what is going to happen in a week, a fortnight, or a month. It is like playing the lottery.
On the other hand, if we look at a much broader horizon, we know that economies tend to grow rather than regress.
To conclude this chapter on investments, we emphasise one of the most crucial aspects of the Money Framework by Pedro Moreira before investing: create an emergency fund first and then start investing with the remaining budget. Some investors would prefer to invest in real estate (and rental property) rather than on the stock exchange. It is a possible path with advantages and disadvantages.
One of the significant advantages is the house location. If well located, the risk of value-change is lower than on the stock exchange. Nevertheless, those who invest in real estate must know that each instance is a case (location, type of construction, neighbourhood).
The big drawback in the real estate sector is liquidity and how fast you can sell a house and keep the money in hand. This factor tends to vary greatly. During the previous crisis, it went from almost immediate sales (less than a month) to more than 12 months. The price adjustment was above 50%, especially in the suburbs of Southern European cities. Real estate can be an excellent mean to build assets if the houses are well selected. Also, if you buy to rent, take in mind the costs related to tenant management.
We know that profitability from the past does not guarantee future returns. Still, we know that the likelihood of money being invested much better in long-term securities than in short-term products is very high and close to absolute certainty (except in extreme situations such as wars).
We all remember the bank insolvencies from the 2008 crisis and all the investors who lost their money from it. Are you willing to lose another EUR 5 000 per EUR 10 000 in deposits (based on past results)?
Dave Ramsey (2016) describes the consequences for the investors who don't treat their money correctly: "Money moves from those who do not manage it to those who do". Are you ready to try the long-term approach and put the money to work for you?
Don't hesitate to share your resource-raising strategy with your colleagues. Recommend Euroconsumers Invest in your company's HR Department. Ask them to contact us and find out more about our counselling services.
Read level 5 of the Money Framework by Euroconsumers Invest: 5. Advice: Invest With the Experts.
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