How To Pick Your Investment Objectives
There are always risks associated with investing. And there’s no point taking these risks unless you have a clear reason to do so. That’s why it’s time to decide the finer points of what your investment objectives are. Do you want to generate extra income to pay for your basic needs? Are you preparing for retirement? Perhaps you don’t have any clear-set need now, but want to invest and save money so you’ll be able to afford to do what you like later in life. In this chapter, you’ll learn exactly how to pick your investment objectives.
In fact, there’s a good chance you have more than one objective in mind. Great! There’s no reason why you can’t have several goals. If you want to, you can pursue each of them with their own investment portfolios, levels of risk and time frames. It all depends on what you want to achieve. This chapter looks in detail at the most common investment goals. We’ll also show you how to pursue them based on best practices.
5.1 Investing To Create Income
How would you like to have a little extra money around for day-to-day expenses? Or money that appears in your account without you having to do anything? It’s a great way to supplement your wages. And to put your money to work for you. Now’s the time to cross your fingers.
Because, it’s possible that one day, your investments will replace the income you earn at your nine-to-five. Just try to tell us that wouldn’t be wonderful! Whether this is the end-goal or not, there are different types of income investments you’ll want to know about.
What are passive income investments?
Any investment that earns income while you do nothing is called a passive income investment. There are several different sorts, all of which have their own returns, characteristics and levels of risk. They include:
- rent and REITs (Real estate investment trusts)
- dividends from mutual funds
- dividends from stocks and shares
- coupon payments from bonds
- retirement funds.
Properties that you lease out are sometimes considered to give you passive income. However, if you want this income, you’ll need to make sure these properties are filled with tenants. To fill the properties with tenants, you’ll need to make sure your property meets all legal requirements and any problems such as a leaky roof or malfunctioning heating system are quickly solved. This means that despite the passive income categorisation, you’ll have to do quite a bit to keep the income coming in …
Note: Some sources make a distinction between passive income and portfolio income. In this case, income from investments, dividends, interests, royalties and capital gains are considered as portfolio income.
Working while you have passive income
There usually isn’t any reason why you can’t continue to work and earn a normal wage while you benefit from passive income. Alternatively, your goal might be to earn so much from your passive income investments that you can rely solely on them to pay your way … In other words? You get to wave goodbye to the rat race and retire early. Use passive income to supplement your regular salary, boost your savings, or invest it to increase your income even more. It’s entirely up to you.
Please remember that as lovely as the idea of passive income sounds, all the investments we have described come with certain levels of risk.
Dividends from passive income investments
The interest you receive on certain investments, such as bonds, is sometimes set in stone. But this isn’t the case when you buy shares of a company on the stock market. The money the company pays out to shareholders is called the dividend. We had a quick look at dividends from shares back in Chapter 3 about the different types of investments. It’s time to look at these dividends in a little more detail.
The amount of a dividend payout is not entirely based on whether the company has made a profit, or on the size of that profit. It all boils down to what the company decides to do with its profits. It’s very unlikely that all the profits will be paid out to shareholders. The company is more likely to hold on to a percentage of the profits, re-invest them, use them to expand, or simply put them aside for a rainy day.
However, there is usually a dividend paid out to shareholders. After all, the company knows it’s important to keep shareholders happy, and that many shareholders have invested in their company specifically to enjoy the benefits of a passive income. The dividend is divided up between the different shares. If the dividend is £100,000,000 and there are 1,000,000 shares, every share earns £100. If you own 100 shares, you’ll receive £10,000. Nice.
But suppose the company doesn’t make a very large profit. Bad news? Investors might not be too happy. For this reason, the company might decide to use its reserves to ensure investors still receive a pretty dividend that will keep smiles on their faces. This practice keeps shareholders happy and helps keep the share price for the company stable.
There are certain companies that are known for paying out greater dividends, often referred to as ‘income stocks’ or ‘dividend stocks’. Major oil companies are among them. As a result, these companies grow more slowly than their competition, because the earnings that have been paid out cannot be reinvested in things like innovation, marketing or growth.
This might not look like a problem to you, especially not if you’re aiming at passive income. However, you should understand that the share price of such companies is likely to grow more slowly than that of companies that keep reinvesting their earnings. In contrast, the share price of companies that prefer reinvesting earnings, compared to distributing dividends, are likely to grow faster in the long-run. This is why such companies are often referred to as ‘growth stocks’.
Tax on investment income
When you decide to invest your capital, whether it’s in bonds or on the stock market, you help the economy to grow. This is a good thing from the perspective of most governments. For this reason, most governments tax passively earned income at a lower rate than income earned at a nine-to-five job. The exact tax rates differ from country to country and fluctuate from year to year.
Make sure you check to see what the tax rates are before you make your investment. Also double-check that your investment will qualify as a passive investment. Every country has its own definitions as to what constitutes a passive investment. If you own too many shares, or have too much involvement, you may not be considered to be earning income passively.
5.2 Target An Amount
What do you dream of? Travelling to the furthest corners of the globe? Owning a house? Or maybe you’re thinking of something a little more out of this world … These dreams are all within the realm of possibility. But only if you have the appropriate funds. It’s up to you to do your homework and decide what your target is.
The next question to ask yourself is when you want to see your investment come to maturity. Now? That would be wonderful, wouldn’t it? But it usually takes time for investments to bear fruit. But this means you can plan ahead. A huge family holiday before your children are too old to be interested. Extra cash at about the time the kids will be enrolling for college. Or a Porsche to celebrate your mid-life crisis.
Maybe you just want to spoil yourself when you retire. It’s entirely up to you. The trick is to make sure you’ve done the maths to ensure your investments will have grown sufficiently by the time you want to make the most of them.
Let’s say that in 20 years, you plan on having €200,000 to your name, whether it’s for a deposit for a home, to supplement your retirement fund or for any of a million other possible uses. You’re going to begin this investment with the €20,000 you’ve saved up. You’ve also done your homework. You know that after fees, taxes and everything else you need to take into account, you’ll receive an average of 6% in dividends every year.
If you’re not using your dividends as a source of income, it’s also possible to pop them straight back into your investment portfolio. And this means that after your first year, you’ll have an extra €1,200 to put back into your investments. After the second year, this amount will grow to €1,470 and it will keep growing down the line. This is called compound interest. And it’s about the coolest thing ever!
With compound interest at an annual rate of 6%, your €20,000 will grow to €64,143 over twenty years. Unfortunately, this isn’t the €200,000 you’re hoping for.
But suppose you supplement the interest by making further investments every month. You invest an extra €300 per month. Or, if you prefer, a total of €3,600 a year. This doesn’t sound too unreasonable, does it? Especially not when you realise that the €92,000 you invest over 20 years takes advantage of compound interest to turn into a total of €200,000!
Would you like to work out your own specific numbers? Bankrate offers a compound interest savings calculator that takes hard work out of the equation. Simply enter your numbers to see what’s possible and what will be required of you.
Keep in mind that return rates aren’t always set in stone. Inflation, fees and taxes are other variables destined to cause complications. And whatever you’re saving up for could have a higher price tag by the time you’re ready to purchase it. Think ahead. It’s hard to be exactly sure of what you’ll need, so aim higher rather than lower. If you overshoot the mark? You’ll have more funds than you need. It’s unlikely you’ll be disappointed.
5.3. Retire Comfortably
The State Pension
About 20 years ago, you could retire comfortably on the pension you received from the state. The story is different now. You’ve probably already wondered about the tens of thousands of warnings from pension providers and financial advisors, all of which tell you that you’ll receive a painfully low income from your state pension. All these warnings are basically correct. State pensions are dropping all over Europe and the UK. You’ll probably receive an amount that you can survive on.
But do you want to merely survive, or would you prefer to actually enjoy your retirement?
You might be expecting a pretty comfortable retirement after working the best decades of your life. And who could blame you for wanting to enjoy a variety of fantastic thrills?
Before you answer, you need to ask yourself what age you would like to retire at. When the grandchildren arrive? When your husband or wife retires? Because it may not be as simple as this. Several countries are currently raising the age at which you’ll need to retire to receive a full state pension. Basically, if you retire before that age, you won’t receive the full retirement pension; you’ll barely receive enough money to survive at all.
Workplace pension plans
The good news is that you might not be relying entirely upon a state pension. You might also be involved with a workplace pension plan. Great! The benefits you receive usually depend on the plan you’re involved in. As a rule, the longer you work, the higher the benefits.
Find out what the specifics of your workplace plan are. What will it pay out to you when it’s time to walk away from work for good? And how will you be able to increase this amount?
By the time you retire, it’s quite possible your expenditure will have changed. Do you need to pay for your different travel costs?
They will presumably be a lot lower when you’re not taking a train to the city every day or driving through congestion charge zones to highly-priced parking garages. The bills at home will drop as your children move out and gain their own financial independence. You’ll also qualify for pensioner discounts on everything from museums and cinema tickets to public transport. There are even utility suppliers who offer discounted rates on gas and electricity to pensioners. Various chemists, opticians and other medical specialists offer discounts to anyone over a certain age.
However, you’ll most likely be paying more for private health insurance, life insurance and other costs. Try to estimate what these will be based on the current rates for senior citizens.
Your monthly costs could change by the time you retire. The biggest change you experience will most likely be linked to your home. Are you paying a mortgage? Most mortgages typically last anything from twenty to thirty years. You pay off the interest as well as the capital you originally loaned.
Is this your situation? Great news. You’ll presumably be the owner of your own home by the time you retire. The mortgage payments you’re currently making will no longer be a part of your monthly expenditure. You’ll still be responsible for maintenance costs. It’s important to factor these into your calculations for a comfortable retirement.
However, there are also mortgages which will see you pay off just the interest on the home loan, not the actual capital. In this case, you’ll likely be responsible for the interest and the maintenance costs. The amount you pay for this type of mortgage is lower than that paid by anyone paying off their home in full, theoretically giving you plenty of opportunities to save.
When you retire, you probably won’t need as large a home as when you were younger and had children living with you. A lot of retired people celebrate their retirement with a move to smaller accommodations that require less cleaning. As a homeowner, regardless of the type of mortgage you currently pay, the value of your home is most likely increasing year by year. If you decide to sell your home and move to smaller lodgings, you’ll be able to use the money you receive for your home to pay off the original mortgage loan. And as the price of your home is now higher than when you originally bought it, after all the taxes and fees, you’ll hopefully have a little extra cash in hand. Great!
Downsizing is also a possibility if you’re renting. You may not want a four-bedroom, inner-city townhouse anymore. A quiet, little cottage in the countryside could be more appropriate to your new lifestyle. The savings you make on rent will help you to fund this lifestyle.
Do the maths
There’s no saying what will happen in the future. This means you’ll have to do at least a little bit of estimation when you try to work out your future expenses. But you’ll hopefully be able to gain some insight into your future financial situation.
Remember your homework from Chapter 4 about defining your risk tolerance? You worked out your general annual expenditure, outgoing capital expenditure, your incoming capital and more. You’ll be able to use many of these costs as a guide here. Your general annual expenditure will be different, especially if you don’t have mortgage payments, have a lower rate of rent in a smaller home, or if your children are independent.
Take a look at what the state pension is at the moment. If you have one, add in the amount your workplace pension plan will be paying you. And now compare this total to your future annual costs. Will your pension be higher? Great! If it’s lower? It’s probably not so great. But don’t give up yet.
Your retirement goal
It’s always possible to secure a higher pension. How? By investing. Invest for extra income. Or aim for a target amount that you’ll be able to live off for a number of years after retirement. It’s entirely up to you. But just remember: the earlier you start investing, the better.
5.4. Investing Ethically
What are ethical investments?
Ethical investing allows you to invest your capital in ventures that meet your religious, moral or personal principles. In other words, you’re supporting companies whose values you share. Socially-conscious funds usually have a single set of guidelines that they follow when establishing a portfolio. Do you agree with their perspective? Find out about their fees, conditions, and the contents of their portfolio and related risks, then make a well-informed decision about whether you would like to invest with the fund.
Of course, you’re always able to build a portfolio of your own. This allows you to take a more personalised approach and be more specific about the stock you invest in. If you hope to bring about social change? Invest in ventures you expect to have a positive social impact. This method is sometimes known as impact investing.
What’s the first step in investing ethically? There are two different approaches:
1. List the type of companies or activities you believe to be unethical and wish to avoid. This is called negative screening. If you remove certain stock from your portfolio for ethical, non-financial reasons, it’s called divesting.
2. List the type of companies or activities you believe to be ethical and wish to invest in. You may find this a little more restrictive.
Exactly what is unethical? Gambling? Alcohol? Firearms? Anything that adversely affects the environment? It’s entirely up to you to decide. And it’s perfectly fine for your perspectives to be at odds with those of someone else.
Ethical investing today
When the new millennium began, brokerages began to offer services for the investigation of various social issues related to businesses. The focus points have included environmental issues, healthy working conditions, fair wages, equal opportunity employment, corruption and have even gone as far as tackling issues such as genocide.
The push for socially responsible investments resulted in the United Nations drafting its different ‘Principles for Responsible Investment’ and encouraging investors to look for environmental, social and governance factors (ESG) before they invest. ESG investing has quadrupled in popularity in the last five years. There are numerous government-controlled funds, ETFs, Community Development Funding Institutions, pension plans and particularly hedge funds that choose to, or are required to, avoid unethical investments and embrace ESG investments.
The bottom line
Do ethical investments have strong returns? Many do. The current trend suggests these returns will become even stronger in the future. Are there risks? Definitely. All investments have some risk attached to them. What about possibly unethical investments? Do they offer strong returns? Many do. Remember that major oil companies pay out lovely returns rather than putting the money into growth … These returns make them very attractive to investors.
The easiest way to decide on whether to invest ethically or not is to answer one question:
It might be because you’ll feel better about yourself. Because you want to take care of the people who are exploited. It might be because you want to sleep better at night. Maybe you’ve always wanted to make a difference, but have simply not had the time, knowledge, commitment or power to do it.
With ethical investing, you have the opportunity to change the world for the better. The history of ethical investment demonstrates that. The best thing is that while you change the world, you’ll be able to earn money doing it.
Does ethical investing work?
What would you think if you deliberately chose not to invest in a company because you didn’t believe the company followed ethical practices? What would you think if the company then changed their practices … ?
One side of ethical investing involves boycotting companies involved in behaviour that is considered to be unethical. The anti-fur movement has had incredible successes in changing the use of fur in the fashion industry. And when apartheid laws were in force in South Africa, international companies were encouraged to avoid investing in South African companies. Unable to find investors, 75% of companies in South Africa came together to demand the end of apartheid.
It’s also possible to ask whether ethical investing, in which companies are deemed to be ethical and therefore deserving of investments, has encouraged companies to implement positive changes before they receive the negative press. You’ll find that many companies have a Corporate Social Responsibility Policy that defines their approach to giving something back to the community. The specific aspects of the policy may not necessarily reflect the areas of focus on which you would like to concentrate, but it does show that there is a recognised need to incorporate ethics in order to meet the expectations of clients.
This raises the question of whether these CSR policies are adequately researched and weighted, or whether they are just advertising tools used to assuage potential backlash. It’s easy for companies to say they support gender equality. But what if their workforce is only 10% female in reality? What if they are committed to environmental causes, but only to the extent of taking actions that also reduce costs?
Ethical investing and the microcredit conundrum
It’s also worth questioning whether your ethical stance actually has a positive effect. It could inevitably be negative. This is a debate that rages in many areas. One of which is microcredit. This is a form of microfinance in which impoverished borrowers, who typically lack collateral, steady employment or credit histories, are offered loans to help them to establish a business and escape poverty. The loans are predominantly offered to women and people in developing countries; 95% are actually paid back.
But critics argue that these loans do not alleviate poverty and don’t really have any influence on gender equality and, most disastrously, actually lead impoverished people into debt traps… Which side is right? And if you were to provide or refuse to help under these circumstances, would you feel as if you were making the appropriate ethical decision?
You probably have several questions and, quite possibly, very strong opinions about this. We promise you that we don’t have definitive answers! Ethical investing is definitely food for thought, but where it takes you is entirely up to you.
5.5. Prepare For Rainy Days
What does the future have in store for you?
When you decide what your investment objectives are, you’ll also need to think about what the future has in store for you. Why? Because things go wrong. You might lose your job. Your car could break down. Medical issues and legal problems often pop up from nowhere. Your investments could collapse, default and leave you almost penniless.
This is why it’s a good idea to keep an emergency fund.
How much money do you need to set aside? This depends on your personal situation. Do you have family members who are dependent on you? Are they nearby or on the other side of the world? Do you have high mortgage payments or rent to pay? Are you paying off a loan for a car or anything else? All these will increase the amount you’ll want to keep in your emergency account.
Putting your pennies aside
Regular expenses don’t just affect the amount you can save. They also increase the importance of putting money aside. This is why you should make sure you have your rainy-day account secured before you start looking at any other kinds of investments. All the more reason to build up your rainy-day fund as quickly as possible. And one way to do that is through investing.
Investing for a rainy day
Look carefully at the investment opportunities available to you. Which ones give you fast, easy access to your capital if you need it? Because these are the investments you’re looking for. You’ll also need to question whether you’ll lose your potential returns if you withdraw your capital. And whether there are fees and costs involved … Be careful! You might find out you’ll have considerably less capital left after withdrawing, possibly even less than you originally invested. And this isn’t the situation you want to find yourself in.
When it comes to a rainy-day fund, accessibility is usually more important than the rate of return. But you don’t necessarily need to invest all your capital in a single investment. Most likely, you won’t need access to every cent at the same time. Make sure there is a healthy amount that you can put your hands on with only a moment’s notice.
A secure investment that you’re quickly and easily able to liquidate is far more important than a high rate of return. The return may help you to build your emergency savings. It will most likely do a better job than leaving your cash in the bank. And it would be wonderful if your return, after fees and taxes, is still above the inflation rate. This means your rainy-day fund will maintain its value over time.
If you never need to break into this rainy-day fund, you might find yourself wondering if you’ve missed an opportunity. Imagine the returns you could have had if only you’d invested the money elsewhere! But also think about the extra stress that would have come with it. And the horrible situation you would have found yourself in if you needed the money urgently, or if your investments defaulted. Your rainy-day fund is there in case things go wrong. It’s not there to make you rich.
5.6 Make More Money
A better return
The money you have saved in the bank doesn’t receive the greatest returns. It’s understandable that you wish to benefit more from it, of course you want to make more money! This is why you invest your savings elsewhere.
You might not currently have plans for your savings. But this doesn’t mean you should be happy watching the value dwindle away with returns that are below the inflation rates, or are less than the fees associated with keeping the money in the bank.
If you don’t have any plans for the money, it’s possible to make more money by investing. Just remember that when you do this, the risk associated increases. This means there’s a greater possibility that you’ll lose your investment money.
Make more money more safely
There is a safer way to make more money. Choose low-risk investments for a longer period of time. If you don’t have any particular plans for the money, there’s no reason not to!
If you make contributions to the capital, you’ll benefit even more. And if you re-invest any returns, you’ll make more money more quickly. This is generally going to be the best practice when it comes to investing over the long term. It requires very little input or time from you, allows you to make more money and keeps risks as low as possible.
You’ll find the different low-risk investment options outlined in Chapter 3. Learn about them and decide which investment is best suited to your financial situation, your goals and your ability and willingness to take risks. Match everything up and you’re well on your way!
5.7 Additional Reading
This guide is for educational purposes only, and should not be seen as financial advice.
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