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How to invest money? Stocks, bonds, deposits, gold, currencies and more

18 august 2021

How to invest money? Stocks, bonds, deposits, gold, currencies and more

Investing is a sacrifice of current consumption for future and uncertain benefits. It is a mixture of time, money and risk, producing gains or losses and distributing them among investors.

The beginning investor should start by accepting a basic truth: EVERY investment involves the risk of losing money. There is no profit without risk (except arbitrage), there are no "sure" investments and no "guaranteed" rates of return. The first lesson in investing is to disconnect from your own illusions and the promises of the financial industry. The second lesson is to accept that you are individually responsible for your investment decisions. A good investor does not explain his or her failures by the salesman's persuasions, a faulty recommendation, or the issuer's fraud. Yes, these things happen, but the losses are always borne by you. You also collect the profits yourself (albeit by paying tax on them. Fiskus somehow does not accept the argument that it should also participate in the losses).

Investment basics
A successful investor works according to a plan. Planning is the foundation of investing. Without a plan, success and failure become a matter of chance. A strategic plan comes down to answering three fundamental questions:

1. what is your investment objective? A portfolio built with retirement in mind is handled differently, a financial "cushion of security" is managed differently, and money allocated to risky speculation is traded differently still. Second, the purpose and nature of your investments determine their horizon. If you're willing to freeze your money for 10 or 20 years, you have more options than if you'll need the cash a year from now.

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2 - How much can you lose on it? This is really a question about your appetite for risk. If you won't be able to sleep at night because of a 20 percent discount in stocks, then investing in the stock market is not for you. The higher the risk you are willing to accept, the higher the returns you will be able to realize. In the financial world, the relationship is simple: the required rate of return increases with the risk you take.

The old rule is: never invest money you can't lose. Don't put your savings for building a house or educating your children into the stock market or cryptocurrencies. And even more so, do not put your "financial cushion", i.e. cash accumulated for a "black hour", at risk.

3 - What is your required rate of return? This is really a derivative of the answer to the first question (how much capital do you want to accumulate and in what time frame) versus the answer to the second question (how much risk are you willing to take). If you don't accept high risk, then you need to limit your expectations of expected returns. There are no miracles in investing: if you want to earn more, you have to reckon with the possibility of incurring severe losses.

I advise you to write down your plan on a piece of paper and keep it in a safe place. It's no joke. Plans not poured into a permanent medium remain just dreams. Secondly, a physically written plan will serve as a benchmark for realized investment results. Regularly comparing the results achieved with the initial assumptions is an excellent school of humility and will likely force the novice investor to revise the assumptions made.

Investing inherently involves not only risk, but also costs. The most important of these is the time you spend on the process. Professional investors devote a lot of time to reading prospectuses, financial statements of companies, analytical reports, recommendations, and their own analysis of information coming from the economy, finance, science, and politics. They do it in order to understand what risk they are taking and what rate of return they can expect. Without estimating these two parameters it is difficult to talk about investing. Ignorance of the relation between income and risk is like gambling, and very unprofessional one at that. This is the best way to lose money.

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The second type of investment costs are all the commissions and fees that we have to pay to be able to invest in something at all. Practically every investment involves some sort of transaction costs. In the foreign exchange market it is a spread, in the stock market it is a brokerage commission, in funds it is a management fee, and in the real estate market it is notary fees. Calculating the return on investment without taking into account the fees and commissions is a big mistake. One should also not forget about the opportunity cost. What is the result if you earned 3% on the stock market in a year if a bank deposit would have yielded 5%? And don't forget about inflation: if it was 3% in a given year, for example, 

Investing: from strategy to tactics
Once you have developed (and written down!) your own strategic assumptions and learned the basic "laws" of investing, you can move on to specifics. The range of investment options is very broad, moving seamlessly from low-risk (but never zero-risk!) deposits to very high-risk investments. In this guide, we'll discuss the different asset classes, starting with those with the lowest risk, and ending with the riskiest investments and those where risk is difficult to calculate at all.

This is one of the safest (at least generally and in the short term) forms of storing savings. The term, however, stretches quite broadly. For most people, it's simply banknotes placed in the proverbial mattress, home safe, safe deposit box, or buried in a jar on the allotment. It is a deposit with low or even zero fees, zero rate of return and relatively low risk. The latter comes down mainly to inflation (i.e., the decline in the purchasing power of money), theft or the loss of legal tender status of a given series of banknotes. The latter risk materializes most rarely (on average every 20-30 years), but results in the loss of 100% of the invested capital. You should also be aware that a banknote series will sooner or later expire and will have to be exchanged for a new one. This operation may also involve various risks, as the residents of India discovered not long ago.

Treasury bonds
These are "risk-free" investments in financial theory (but we already know that they don't exist), usually yielding low interest, the payment of which (as well as return of the capital) is guaranteed by the state with the whole tax, military and police apparatus behind it. In practice, governments very rarely go bankrupt on bonds issued in the national currency, which is why treasury bonds are considered the safest security. Finally, countries also have central banks that can "add" any amount of money if necessary.

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With (theoretically) low risk comes low interest. As a rule, bonds issued/guaranteed by the Treasury have the lowest interest rates of all bonds in a given country. In Poland there are two groups of treasury bonds. There are securities listed on the wholesale market, which are traded by banks, investment funds, insurance companies or foreign institutional investors. An individual investor may buy wholesale treasury bonds either on the Catalyst market through a regular brokerage account or through a bank, which is usually reserved for clients with a sufficiently large portfolio as part of private banking services. When you buy Treasury bonds on the secondary market and sell them before maturity, you assume the risk of changes in the market price of these securities.

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However, retail Treasury bonds are available to everyone. To buy them, all you need to do is open a special account with the brokerage house PKO BP. Purchase orders can then be placed online or in person at PKO BP branches. Currently, the offer of retail treasury bonds includes 3-month papers (paying 1.5% annually), 2-year (2.1%), 3-year (their interest rate depends on the Wibor rate), 4-year (inflation-indexed), and 10-year (inflation-indexed) papers. There is no secondary market for these securities - you can't sell them to someone before maturity. In return, we receive an early redemption option. In such a variant, the Ministry of Finance will give us our money back a few days after we submit our instructions, but it will deduct a fee for early redemption (the amount depends on the type of bond and is written in the issue letter).

Bank deposits
Putting money in a bank deposit is one of the oldest and most conservative ways of investing spare cash. Nowadays it is considered a low-risk investment, but this is not entirely true. In Poland the last case of commercial bank's bankruptcy took place in 2001. Then only small (and one bigger) cooperative banks and SKOKs went bankrupt. Each time, depositors were satisfied by the Bank Guarantee Fund, which insures deposits up to the equivalent of one hundred thousand euros. So far, the BFG has not faced the challenge of the collapse of a large commercial bank.