Tailor-made investments–Part 1

QUESTION: I am 25 years old, gainfully employed and looking for an investment opportunity. My parents have encouraged me to do so while I am young. Can you help me sort out my options? —asked at “Ask a friend, ask Efren” free service available at www.personalfinance.ph and Facebook

Answer: The very first step to investing is to establish what you are investing for. Do remember that making money is never the goal. Money is just the tool to achieve a loftier goal such as providing good education for your future children, putting a roof over your head, setting yourself up for a comfortable retirement and others.

Money is the ladder to reach your goal. With the exception of getting inheritance or gifts and marrying into it, you will need to work hard for money. The best way to make more money is to spend less than what you earn and supply the difference to a business. Note the emphasis on “more” because being an employee, you are already making money; you just need to “turbo-charge” your money’s growth by investing it.

You can look at business as the “factory” for money. You can supply a business with money for its operations in an “RTW” (ready-to-wear) or tailor-fit fashion. Let’s start with RTW.

By supplying money in an RTW way, you are buying ready-made investments. Whenever you put money in a savings or time deposit account, you are supplying a bank with money in return for short-term RTW investments. The interest rate and tenor (for time deposits) on these short-term RTW investments are pre-determined. Some say they can hardly be considered investments because of their low interest.

Treasury bills and commercial papers are also short-term RTW investments. With Treasury bills you will be supplying money to the government, which is in the business of governing the country. In return, the government promises to pay a fixed interest over a period no longer than one year. On the other hand, you will be supplying money to private sector businesses to fund their working capital needs when you buy commercial papers. And like treasury bills, commercial papers will pay you fixed interest over a period of no longer than one year. As a footnote, while commercial papers are by nature short-term in tenor, there are long-term commercial papers available.

Also note that banks serve as sellers of treasury bills and commercial papers whose issuers are the government and private sector businesses, respectively. If things go wrong with your investments, particularly with the repayment of interest or principal, you will need to run after the issuers and not the bank.

Based on current market conditions, you will earn less than 3 percent per annum, gross of the 20 percent final withholding tax on interest income, if you supply money in return for short-term RTW investments.

You can supply money to the government and private sector in return for long-term RTW investments. These will come in the form of notes/bonds and stocks. Basically, notes/bonds are like time deposits except that their original tenor will be longer than one year. Interest is paid either quarterly or semi-annually while the money you supply will be paid back on maturity date. There are also zero-coupon bonds where no interest is paid during the life of the bond. You will supply money at the start at a discount to what you will be repaid on maturity date. The difference represents your interest over the period.

As of this writing, the interest rates on government notes/bonds range from 3 to under 5 percent per year, gross of tax and depending on the tenor. Rates are higher for private sector notes/bonds. Again, you have no say on how the notes/bonds are structured, hence their being RTW investments.

There is a law that exempts notes/bonds from the 20 percent final withholding tax on interest income. But the conditions are that the notes/bonds must have a maturity of not less than five years and that these be issued by banks. For a more complete discussion on this tax exemption, please refer to BIR Revenue Regulation 14-2012.

You may get your money back from notes/bonds before maturity date by selling them on the fixed income exchange. Remember the basic rule that if interest rates go up, the value of your notes/bonds go down and vice versa.

In the issue, we will talk about stocks as RTW and tailor-made investments. For now, to know more about the options in investing, visit www.personalfinance.ph. There are free tools to clarify investing for you. You may also wish to attend our EnRich™ Wealth Management training program on April 11, 2015 or our Financial Planner’s Training program.

(Efren Ll. Cruz is a registered financial planner of RFP Philippines, personal finance coach, seasoned investment adviser and bestselling author. Questions about the article may be sent by SMS to 0917-505-0709 or e-mailed to [email protected]. To learn about value investing, attend Accredited Financial Analyst (AFA®) on April 25 to May 30, 2015. To inquire,email [email protected] or text <name><e-mail><AFA> at 0917-3464126 to register.)

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