Tag Archives: investment

The Difference Between Saving and Investing

All of us want to grow our hard earned money. So at early age we were taught that the only way is to open a savings account and save everything in the savings because it will grow. However, as finance continue to progress, this advice no longer applies. For one, the interest rates are so low and the rate of return is so minuscule that it defeats the purpose of saving money in a savings account.

Don’t get me wrong. Saving money in a savings account has its benefit too. For example, it is usually the source where you can use to pay for your daily expense or your “rainy day” funds. What you should not do is to use your savings account as your retirement income. Another other option to grow your money is to put the money in an investment account. History facts indicate that the money in investment account grow at a faster rate that what you have in the savings.

I’m not going to defend one over the other because both have its pros and cons. The better strategy is to have both. The question is how much you put in both. There is no right or wrong answer because it depends on personal lifestyle and your current condition. For example, if you are now in dire situation where you may not be able to afford food on the table, putting money in the a investment account is not advisable. However, if you have sufficiently money saved to last 6 months should you lose your job, then you should consider move some of the funds to an investment account.

Risk

Investing in stocks (or any financial instruments) carry a higher risks than saving your money in a savings account. The major risk is a potential loss in value. On the other hand, the money you save in savings account will not lose value unless there is hyper-inflation in the economy. While the risks in investment exist, the pros sometime may surpass the cons. The best strategy is to invest only the money that you are willing to loose. You should never borrow money to invest and never invest your entire life savings in any investment account.

Rate of Return

Banks usually guarantee a return on the money you save in the savings account. These are called interests. However, the rate of return depends on the interest rate controlled by the Federal Reserve Bank. The interest rate today is at 0% because the Fed is trying to stimulate the economy by making borrowing money cheaper. On the flip side banks are offering less interests for existing savings account and that means the rate of return for the money you save is also less.

The rate of return on investments continue to on an upward trend despite the negative trend on the economy. As an example, a $6,000 dollars that I invested in a traditional IRA account in early March has a balance of $6,400 today (early June). Assuming that there rate of return is the same for the remainder of the year, that is equal to almost 20%.

Liquidity

Money saved in a savings account is considered a liquid asset. That means that it can be easily changed into cash and be used immediately. Depends on the type of investments, some assets are not easily converted into liquid asset. Examples such as retirement accounts (i.e. 401K and IRAs). Withdrawing money from these accounts could involve penalties and high tax rate. Money invested in stocks can be converted to cash but usually take several days depends on the banks or brokerage firms. If you are in an emergency, it could mean life or death.

It is important that everyone of us should consider these factors and understand one’s financial condition to determine what is the right mix when it comes to putting money in savings account and investment account. Both accounts have pros and cons. If you are interested in growing your hard earned money, putting the money in investment accounts is a “no brainer”. However, if you want to have a peace of mind and willing to forgo the potential income that investment accounts may bring, savings account is your only choice.

Is Robinhood Dangerous?

The stories that we heard and watched so many time how Robin Hood swooped down from a tree and robbed from the rich and gave to the poor were classic in itself. Hence, we all automatically infer that Robin Hood was the good guy.

However, today we are not discussing the person from the folklore but the application (app) that was recently put under the spotlight for causing a 20 years old man to commit suicide after finding out that he lost $730,000 betting on options. It was sad to say the least and really unfortunate to have such a tragedy inflict on a family. However, I’m not here to discuss what went wrong with app but to argue if Robinhood is dangerous?

Before I continue I want to state my position. I don’t think the app is dangerous, but I think the tragedy could be avoided if there is failsafe built on the app that would flag any anomalies in trading. I am neither a programmer or developer so I am not in the position determine if there is any artificial intelligence or models built in that would capture these anomalies. News outlet claim that there was a system error in the balance of the 20-year-old which ultimately led to the death of the trader. Could this be a “freak” error that could not have been thought of by the app developers?

If you read my earlier posts, I pointed out that trading was originally reserved for the riches. The revolution started when Robinhood allowed the mass to trade for free beginning in 2013. Since then, there are a lot more companies are using the same business model. Even the large and established investment companies have started to offer free trading to their customers. Did Robinhood started something that increase trading risks, particularly for the milenials?

Fine Print in Trading – Trading in financial markets is risky. The inherent risk is high and anyone who is involved in trading should understand the risk. Before anyone who wants to begin trading, he or she should know this and should set a risk tolerance the he or she is willing to take. Trading is not FDIC insured and this is clearly stated in the agreement before an account could be opened. Additionally, all agreements also state the risks involved in trading.

Some brokerage firms also try to protect investors by assess their portfolios to ensure the risks are reduced. For example, I was prevented from buying stocks in my Citigroup brokerage account because I have 100% of my portfolio in equity stocks. To reduce the risk, I was advised to diversify my portfolio.

Good Knowledge in Trading – Trading in financial markets is different from purchasing a product in Amazon. You look at the product to see if it meets your needs. Then you find out if it is reliable by reading the reviews. Trading in financial markets require not only the stocks itself you need to understand how the financial instruments. I personally am not well versed in all the different instruments available so I am not going to attempt to explain each one of them.

Equity trading is perhaps the easiest – buy low and sell high to make the profit margin. However, for someone who is new to buying stocks, you do need do some research on the stocks you are buying. Reading the market news is perhaps the easiest way to do research. Options trading is perhaps the most difficult to understand. And option is an contract that allows an investor to buy or sell an underlying instrument like a security, ETF or even index at a predetermined price over a certain period of time.  A trader will need to have a good understanding how it works, what to bet on, and has a high level of risk tolerance. if you place your “bet” right the profit margin could be great and the opposite is true. The 20-year-old trader may not had understood this and bought options based on someone’s suggestion.

Don’t Be Greedy and Understand the Risk – The old adage that there is no free lunch is very true in the trading business. Don’t expect to double what you invested in a short period of time. Time commitment and upfront asset are required. Once you started the investment you are required to keep investing for a long period and hopefully the amount you invested will continue to grow over time. Being greedy and hoping a payout not only it is impossible, the risk is extremely high. As an example, a trader could invest in a “hot” stock that has recently been increasing in price due to an unusual market conditions. However, once the real news come out it could unravel really fast and there is a high possibility of losing all the money you invested. I had the unfortunate opportunity to invest in China’s Starbucks called Luckin Coffee earlier this year. After reading one of the articles in a magazine how the company became a rising star in the Nasdaq stock exchange. The stock went from $19 to $50 in just a year. When news came out that the company fraudulent boost its earnings, the stock price quickly dropped to $4 and was subsequently de-listed from Nasdaq. I lost lost to $900 after selling the stock for $2.50.

Know One’s Limit / Know When to Back Out – Anyone who is interested in investing in stocks must have a good understanding on his or her current financial situation first. If someone who carries a large debt, investing may not be a priority. If the person does not have extra liquid assets committing the asset in stocks is not advisable. A large portion of my investment is in 401k retirement plan. I only invested about 20% of my liquid asset in the open market and of those 70% are in equity (or individual stocks). I tried to keep my risk low but at the same time want to grow my asset at a steady pace. I continue to read the business news and stock market highlights to understand the market conditions. If for any reason that there is adverse market conditions I will only lose 20% of my asset.

What had happened to the 20-year-old was really unfortunate. Robinhood could be the cause but in no way directly responsible for the tragedy. Legally there is a clause in the agreement noted that there is a risk in all types of investment. Without a good understanding of how the financial markets work will only increase the risk when it comes to investing.