Investment vehicle options and risk | Investments for beginners

Investment vehicle options and risk | Investments for beginners

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Every investment is risky, even cash. You  must be thinking of. Avanti has gone nuts.   How is cash risky? Well, I'm not crazy.  And I'm going to prove it in this video.   It really depends on how you define risk  and you need to determine what kind of risk   is acceptable to you as an investor. To do  this? You must look at your investment plan. Create one. If you haven't already. In the  description, I share my personal investment   template and this video right here guides you  on how to use that investment template. Hi, there I'm Avanti. I'm a mom and  investment. Okay. And a CFA charter  

holder and I've helped dozens of women  take control of their financial future. Subscribe to my YouTube channel and follow my  Facebook page to learn how you can build your   own wealth through investing. In this video. I'll  then talk about the different types of investments   available to you, how to make money from those  investments and the types of risks associated with   each investment. We're going to map all available  investment options on this risk return grid. On the X axis we measure  risk. So as we move from left  

to right, the expected risk goes up.  And as we move from bottom to top,   the expected return goes up. So investments that  are on the bottom left corner have lower expected   return and risk and investments that are in the  top right have higher expected return and risk.   I'm using historical average returns to measure  expected future returns. Note that these are not   guaranteed future returns . And I'm using  standard deviations as a measure of risk.  

And the reason we're using standard deviation to  measure risk is because it gives us an idea of how   much the returns drift about are below the mean.  If the historical standard deviation is high,   the investment has had a wide range of returns and  is deemed more risky. Typically higher investment   returns come with a higher risk. The idea here is  that if an investor is willing to take additional  

risk, he or she needs to be compensated with a  higher return for taking on that additional risk. There are many different ways you can  measure risk, but on this risk return grid,   we are only mapping risk that is associated  with volatility or standard deviation. So let's start. Investment vehicle  number one, let's talk about cash.   So cash includes the cash that's in your wallets  or purses or the cash in your checking account   or the cash under your mattress. If you are  that person . The return on cash is zero,   which means you don't earn any  interest on that cash that you hold.

You might think that the risk in cash is zero as  well. And that's true. If you measure risk just on   this risk return grid, in terms of volatility,  cash has zero risk. So if you stash a hundred   dollars under your mattress today after 20  years, you will still have a hundred dollars.  

But in 20 years, that hundred dollars will be  worth less because of something called inflation. Every year, prices of goods and services tend to  creep up. There may be some years where prices   have fallen, but in general prices tend to inflate  or go up. In fact, in the post pandemic world,  

you may have already noticed large price increases  in everyday purchases. Hundred dollars in 1980   could buy you 47 gallons of milk. If instead of  investing or spending that a hundred dollars,   had you stashed it under your mattress,  that same hundred dollars today will buy you   only 27 gallons of milk. So do you see how  inflation that is increase in the price of milk   has reduced your purchasing power because milk  costs a lot more today than it did back in 1980.

Instead of stashing that hundred dollars  under your mattress, had you invested it   in the S&P 500 index today, those hundred dollars  would have grown enough to be able to buy you   2,110 gallons of milk. I'm  not a psychopath. I promise   I don't have thousands of gallons  of milk in my refrigerator. I'm just trying to explain you how  cash is the worst investment vehicle.   If you factor in inflation, of course you  need cash for your day-to-day purchases,   but don't use cash as an investment.  I'm going to share a fun fact. Eight November, 2016, my Indian friends  will never forget this date 8:15 PM.   PM. The government of India announced that two  denominations. So the Indian currency is the rupee  

thousand rupees and 500 rupee bills  will be voided; no longer considered   legal tender. And those of you who  don't know, India is a big cash economy. So even substantially large transactions  take place using cash. Imagine holding a   huge stock pile of cash. And in a minute,  the government just announced that it's   no longer going to be considered legal tender.  That's a tough situation to be in and not,   not such a fun fact for people who went through  that demonetization, which was done to combat   tax evasion, unlikely to happen  again but something to consider. So don't hold a lot of cash. Investment  vehicle, number two savings account. Savings  

accounts , give you a little bit of interest and  keep your money safe. The interest rate, which is   also known as the annual percentage yield or APY  is typically very small. And the interest that   you earn is taxable. Once you keep your money in  a savings account, the interest rate is not fixed. It changes as the central bank or the Fed  hikes or cuts interest rates. So for example,  

in 2019, Goldman Marcus offered 2.25%  on their online savings account.   And as of the day of this recording, the rate   stands at 0.5%. A savings account is a  perfect place to stash your emergency fund. The upside is not very high. That is your capital  will not appreciate by significant amount,  

but you will be able to preserve your capital for  emergencies. Look for banks that are insured by   the FDIC or Federal Deposit Insurance Corporation,  or if you plan to use credit union to open a   savings account, make sure that the credit  union is insured by the NCUA or the National   Credit Union Administration, or you can choose  an online money market account or a high yield   savings accounts such as Goldman Marcus or Ally  Bank. Just make sure that these banks are insured   by the FDIC or NCUA. to make sure that the money  you're stashing is perfectly safe. Some of these   online banks limit the number of transactions that  you can make the withdrawals to about six a month,   investment vehicle, number three,  CDs or certificates of deposit. These are very similar to your  savings account with some differences   While a savings accounts offer the  flexibility of making withdrawals   CDs don't. CDs offer a slightly higher rate  than savings accounts, but this comes at the   cost of access to your money. In the US  interest rates on CDs are awfully low,  

but there was a time during the 1980s, when you  could earn double digit interest rates on CDs. CDs are offered for a term, and your money  is locked for the term of the CD. Terms can   be short suggest three months or long, like one  year, two years, five years. , and in some cases,   even 10 years, your money stays locked with  the bank for the entire term of the CD. If you need to withdraw your money before the  CD matures, you will pay an early withdrawal   penalty. Now, quick quiz for you - can a  bank change the interest rate on your CD? Can they say tomorrow that we are not profitable   anymore and we just don't feel like it. So instead  of the 4% that we promised you at the beginning  

of the term, uh, we are going to pay you  just 0.5%. Can they say that? The answer is   no. Once you open a CD, your interest rate stays  the same through the entire term of the CD. However, once you open an account and tomorrow,  you bring your sister to the same bank,   she can get a different interest rate based  on what rates they're offering on that   date . And that rate will remain constant  throughout the term of her CD. Another pop   quiz. What do you think is the risk in  opening this type of investment vehicle. If interest rates rise during the term of your  CD, you cannot withdraw from your current CD   without incurring a penalty. So say  for example, today you open a new CD   for a term of three years and tomorrow  banks start offering a higher interest rate,   the penalty that you will incur by  withdrawing from this original CD,   maybe higher than the potential return that you  may get from switching. And by the time your CD  

matures, the interest rates may be lower than when  you started. If you're still with me, don't forget   to hit the like button. And if you haven't already  please subscribe to my channel. So you get access   to all my latest videos. And if you're watching  me on Facebook, don't forget to follow my page. I keep adding new videos on  building wealth through investing   and to help you better allocate your income.  I have linked my personal budgeting worksheet   in the description. So don't forget to grab that.

Moving on to vehicle number four T-bills. T  stands for treasury. T-bills are short term   debt securities issued by the US government. In simple terms when you buy a T-bill, but  you are giving the government your money   to use for ongoing expenses, in exchange, you  receive a promise from the government that you   will get your money back with interest. T-bills  are short-term debt securities, which means they  

have maturities ranging from a few days to  a year. The amount that the government pays   you back at maturity is called the par value and  T-bills are sold at a discount to this par value.   The amount of the discount is determined  at the auction. Getting a discount on this   par value is like earning interest. And this  interest is exempt from state and local taxes.

You do have to pay federal taxes on the interest.  You can buy T-bills directly from the government   or on secondary markets. To buy directly. You  have to go to treasury It's linked   in the description. As an individual investor or  a retail investor, you would bet non competitively  

at the auction, basically just bid the amount of  T-bills that you're willing to buy at a discount   rate that is going to be set at the competitive  auction, which you don't have to worry about. The discount rate gets determined through the  competitive bidding process by institutional   investors. So this is the announcement page of  treasury, where you will see auction   dates for treasury securities. On auction date,  you are able to place your non-competitive bid   until 11:00 AM eastern standard time. Competitive  bidding closes at 1130 Eastern standard time,   which is when the discount rate is determined.  This page here shows one announcement from march  

of 2022. These announcements are made several days  before the auction. It tells you the term of the   security. In this case, it is 91 days or three  months, the auction amount, the auction date. And so on. At the end of the competitive  auction, you will be able to see the yield   that you will receive. In this auction  on March 14, the yield was 0.45%.   Using a simple calculation, 0.45 times the term  of the T-Bill, which is 91 days divided by 360   gives you the discount on a par value of 100. So  essentially you would be able to buy a hundred  

dollar T-bill for the discount of 11 cents or a  price of 99.88625, which is this price right here. If you are buying thousand dollars worth of  T-bills, you could buy them for $998.8625.   At maturity that is on June 16th, you will  receive your par value back. The interest   rate you earn on T-bills are super low and you  could earn a higher yield through online savings   account. However, it's good to be aware  of different investment options because  

interest rates are always changing. T-bills are  one of the safest investments you can ever make   because they are backed by the full faith  and credit of the United States government.   But also note that the return  on T-bills is super low. There's always interest rate risk in that existing  T-bill holders will lose out on a higher interest   rate if interest rates are rising. But again,  these are short-term securities with maturities,  

less than a year. There are many different types  of risks associated with bonds. But before I go   into the risks, I want to tell you about the  different types of bonds you can invest in. Vehicle number five, treasury notes and  bonds. Treasury notes have maturities between   one and 10 years and Treasury bonds have  maturities of 20 or 30 years. These are   issued by the United States government.  Both treasury notes and treasury bonds   pay semi-annual interest. And these  interest payments are called coupons.

Similar to treasury bills or T-bills treasury  notes and bonds are backed by the full faith   and credit of the United States government.  By purchasing these treasury notes or bonds,   you're giving the United States government your  money to spend on projects, such as highways and   bridges, et cetera. And in the dome, the  government promises to pay you back at maturity.   In addition to that, the government also  sends you semi-annual interest payments,   which are known as coupons. Back in the day when  you bought a treasury note or a treasury bond,   you would actually get a physical piece of  paper with detachable coupons. So for example,   if you bought a 10-year note, you got a paper with  20 detachable coupons, which you could cash in   for semi-annual interest. These interest  payments are exempt from state and local taxes.

You still have to pay federal taxes on You can buy  these bonds and notes directly from the government   through treasury,, or you can also buy  them through your brokerage account information   about upcoming auctions can be found on this  website. . It's also linked in the description. At the end of the competitive auction, you should  be able to see the results that will give you   some very valuable information. Here are the  results from the auction of February 9th, 2022.   It tells you the term of  this note which is 10 years.  

The interest rate is one and seven,  eight of a percent, which is 1.875%. So if you buy a note with a par value or face  value of hundred dollars at the end of the 10   year term, you will get a hundred dollars back.  And every six months you will receive 1.875   divided by two, which is 0.9375 or 93.75 cents.  Because remember this is a semi-annual coupon.   So we have to divide by 2. How much do  you have to pay for this note today? For that we need a third piece of information,  which is the high yield of 1.904%. I use a simple  

present value calculation to get the value you pay  for the a hundred dollars part value note. And it   comes out to $99 and 73.707 cents. Because this  value is below the par value of hundred dollars.   This note is set to be trading at a discount. Bonds can also trade about par value , and  you can get compensated through a higher   coupon rate. Let me know if you're interested  in learning how I calculated these numbers,   and I'm happy to do a video on bond math.  There are other treasury instruments,   such as I bonds are tips for treasury  inflation, protected securities.

I bonds that especially attractive now  because the inflation rate is very high.   So I hope that gave you an overview  of treasury related debt instruments.   Now let's talk about municipal bonds on munies,   which are issued by local municipalities. So  by buying a municipal bond, you are giving  

a local government, your money for projects,  such as building schools or hospitals or parks. And the way municipalities make money is through  taxes. Munies are tax exempt, but even though they   are issued by local governments, these are not  risk-free. Many munis have defaulted on debt.  

The most famous being jefferson county, Alabama,  that defaulted on billions of dollars of debt. As always I'm not scaring you from investing,  you need to be aware of all the risks before   you make any investment decisions.  Don't put all your eggs in one basket.   Creating a well-diversified portfolio is key to  minimizing risk and generating strong returns   that will meet your investment goals.,  Investment number seven, corporate bonds,  

similar to governments issuing bonds for ongoing  expenses. Companies can issue corporate bonds   for making a new acquisition to pay existing  debt for R and D. And so on the type of interest   you get on a corporate bond is typically higher  than what you can collect from a government bond.   Why? Because these are not risk-free. Remember  investors, will demand to be compensated for   taking additional risk. So if a company is deemed  to be more risky, the demand for that bond will   be lower and investors will demand a higher  interest rate before they touch that investment.

Corporate bonds pay interest. Semi-annually we  go. Number eight, mortgage backed securities or   MBS. Mortgage backed securities are similar  to bonds, but instead of a government   or a company or a local municipality issuing  these bonds these bonds are backed by mortgages.   So when you buy a house more often than not, you  will get a mortgage from a bank. A bank issues  

like hundreds or thousands of different mortgages  and they can combine these different mortgages   into a security and then sell these securities  to investors. In exchange, the bank gets money   from the investor. And each month, when you, as a  homeowner makes those mortgage payments, the bank,   takes the mortgage payments from the homeowner and  it passes them to the MBS owner or the investor. So each month, uh, MBS holder will get  an agreed upon payment from the bank.   So bonds are known as fixed income securities.  You may have heard of this term fixed income.  

Typically when you hold a bond to maturity, you  know, what kind of payments to expect at each   period. So if it's a government bond who know what  kind of coupons to expect every six months, So you   get a fixed income and you know what to expect at  maturity, hence the term fixed income security. However, just because they're called fixed income,  they are not risk-free. I mean, treasury bonds are   different types of bonds have different types  of risks associated with them. Not all bonds   are created equal. Before I talk about risks  of bond investing, a quick reminder for you to   show me some love by hitting the like button and  subscribing to my channel if you haven't already.  

As is true with any kind of investment bonds  come with some risks. , I would highlight some   of the more understandable risks associated with  bond investing. First is interest rate risk. The price of a bond moves in the opposite  direction as the interest rate. So let's   say you bought a 20 year bond from Verizon that  pays 5% coupon and you bought it at part of value   of a hundred dollars. So it's a corporate  bond. So par value is what you will receive at   maturity. And there is no discount because  you bought it at par value, you bought it. A hundred dollars. So the yield for this  bond or the interest rate for this bond  

is 5%. So let's say tomorrow  interest rates rise. And Verizon   starts issuing new bonds that yield  6%. Now you want to sell your bond?   Can you sell it at par value? Can you sell it at  a hundred dollars that you bought the bond for? No, because market interest rates have risen and  an investor will demand a higher coupon rate of 6%   because Verizon is currently issuing bonds at 6%.  Can you force Verizon to change the coupon rate   of your existing bond from 5% to 6%? Again, the  answer is no, you cannot. So instead to compensate   the next buyer for that additional interest rate,  you will have to sell your bond at a discount.

In this case, it comes out to 94 point 45. So $94  and 45. Because the market interest rate rose,   you now have to sell the bond at a discount  of $5 and 55 cents. So if you hold a bond,   the value of your bond holdings will rise. If the  interest rates go down and the value of your bond   holdings will fall if the interest rate rises.  So that's interest rate risk in an nutshell,   The second risk is prepayment risk.  So if you've got a loan from a lender,  

have you asked this question? If there are pre  payment penalties, it's an important question.   If you're getting a loan, always be sure to ask  your lender if there is a prepayment penalty. What's a prepayment. Sometimes if the  interest rate on your loan is very high.   Or if you have extra cash on hand and  you're trying to pay off your debt   faster, you will make extra payments  towards that loan. So any extra payment   then goes towards the principal  of the loan is called pre payment.

And most of the times you will do it in order  to reduce your interest burden over the term of   the loan. Another time prepayment can  happen is when you refinance a loan,   see you got a mortgage, a 30 year mortgage at  4% interest rate, and then fed starts lowering   interest rates, and that affects  your mortgage rate in the market. And then you're able to find another lender  who was able to refinance your loan at 2%.   What happens then is this new lender pays off the  entire amount of the loan balance to the current   lender. And you as a homeowner starts making  your new mortgage payments to this new lender.

Now let's see what happens on the lenders side.   So remember I just talked about mortgage backed  securities. What happens is a lender will combine   multiple mortgages into a security and sell  it to investors. And as the lender receives  

mortgage payments from homeowners, the  bank passes those payments onto investors. Now in a falling interest rate environment, many  home owners will refinance their mortgage . So   this lender would receive cash payments  in a lump sum, which it will then pass on   to the mortgage back security investors.  So these. Investors will now receive   lump sum cash payment, which then they  have to invest at a lower investment rate. So this gives rise to a third type  of risk known as reinvestment risk,   because remember the overall market interest rates  have dropped. So you will have fewer opportunities   of bond investing this lump sum amount at a  higher rate. The fourth risk is credit risk.  

A bond issuer can default on principal  or interest payments in some cases,   because they don't have  the money to pay investors. If they're going bankrupt or  something. In some cases like Russia,   it's because of sanctions. So let  me tell you what happened in Russia.   Russia has billions of dollars of debt in dollars  and Euro. Russia has an outstanding debt of 40   billion. Us dollars interest payments of  $117 million were due in March of 2022. And these were dollar denominated  debt. Dollar denominated means  

the payments have to be made in dollars.  Not euros, not rubles , just us dollars.   Now Russia has $600 billion of foreign  currency reserves. But because of the   needless and senseless war they started in  Ukraine the US froze, some of their assets.

There a few days when markets were  worried, that Russia was going to   default on interest payments. due in  March. Which they were able to make.   Eventually there are more payments coming  up , so we'll see what, what happens then. There's also downgrade risk Bond  issuers can be downgraded by   rating agencies, such as Moody's Fitch or  Standard & Poor. When a downgrade happens,   investors demand a higher interest rate to buy  that bond. So if you're an existing bond holder,   The value of your holding will go  down when there is a downgrade.

This point here on the chart shows the risk and  return of an index of investment grade bonds   that include treasuries, corporate  bonds, mortgage backed securities,   and so on. Investing in a diversified pool  of bonds will reduce your overall risk. There   are seven other kinds of risks, suggest sovereign  risk, volatility risk yield curve risk and so on. But I hope I was able to  give you a general overview   of the different types of risks associated with  bond investing. I'm giving you a little bit of   homework here, log into your 401k account  or any retirement account you may have and   check the types of bond funds that you're invested  in. Bond funds are suitable for tax advantage  

portfolios, such as retirement accounts and  not your regular taxable brokerage accounts. Why? Because bonds give interest  income and interest income   is taxed at your regular income taxe  rate. Which is higher than the rates your   qualified dividends get taxed at. So your  homework is to go and check the composition   of bond funds in your portfolio. Let me  know in the comments, what do you find out. Being aware of where your money is invested and  how you're diversified is really important. So  

I hope this section gave you an overview  of bond investing. Because I told you I   would give you an overview of all available  investments. I want to talk about four more   investments. The first one is alternatives.  This is private equity, venture capital   and hedge funds. Many retail investors don't  have access to these types of investments. They're not publicly traded and most retail  investors don't have access to these types   of investments because of regulation. These  investments Do require, investors do have  

a certain level of income or assets. So I will  leave this asset class for a future session.   The next one is real estate. I've  included residential properties,   office space, storage space, hotel  properties, et cetera in this dot. Some people like the consistency of regular  rental income that comes with owning a property,   but don't ignore the risk. Awareness  is key. Like when the pandemic began,   if you were a landlord that owned a lot of  office space, which short term leasees .

You may have lost money because a lot of companies  decided to. To remote work and office space was   empty. So imagine being a landlord with  a big portfolio of office rental space,   not a pretty situation to be in. REITs  another option that will give you exposure   to real estate without the  hassle of owning property. But the income that comes from  owning REITs is not qualified,   which means it gets taxed at a higher  rate, which is your income tax rate,   rather than the rate that qualified dividends  get taxed at, which is the capital gains tax. The   next week is commodities. It includes three main  categories, agriculture, which includes commodity,  

such as corn, soybean, wheat, sugar, coffee,  capital, pork, et cetera, energy commodities,   which includes oil and natural gas and  metals, which includes gold platinum, copper. Buying and selling actual commodities,  actual physical commodities is tedious   and time consuming, especially if you're not in  the commodity business. So an easier way to get   exposure to commodities is either through ETFs  or companies that have exposure to commodities,   such as a mining company, , are  through, , futures contracts,   which comes under a special class of  investments, known as derivatives. I will cover the derivatives in a future. And  finally, I want to touch upon cryptocurrencies.   I could not place cryptocurrencies on this  chart because the risk and return both are   off the charts. I will share, my  feelings about crypto in a later video,   but here's what I think about crypto  in brief crypto is super speculative.

It is not backed by anything  and could disappear in no time.   Having said that if you have , the risk appetite  for crypto, do your research and invest,   but only invest your fun money in it don't let  crypto be more than 5% of your total portfolio. I want to use a diet analogy in this case. To stay  fit. You need a balanced diet, a combination of   carbs, protein, fat water, fiber, and so on.  Similarly, you need a good balance of all the  

assets I went over in a healthy combination,  too much of anything is going to be harmful, consume a lot of carbs and you will gain  weight, consume a lot of protein and you know,   what's coming next constipation. Crypto  is like dessert on your portfolio plate.   Having a little bit of it. It's not going to hurt  you. In fact, it'll make you feel really good,   but making a whole meal out  of it will hurt your big time. Going back to the risk return grid you may  have noticed, I did not talk about any of   the stock investments that's because in my next  video, I'm going to talk about the stock market. That video is going to be the first video  in a series on the basics of stock market.  

If you are new to investing, it will be a  great video for you to attend because I'm   going to explain concepts in a way that  even my five-year-old can understand.   And if you are a veteran investor,  it will be a refresher video for you. So make sure to subscribe to my channel and hit  the bell icon. So you don't miss it. That's it   from. Or this week as always, don't forget to  be happy to be kind and to be your best self by.   And here are some more videos  I think you will enjoy. I would really appreciate  your hitting the like button   and sharing this video with your friends and  family. It will help me reach more people.

2022-04-11 22:41

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