Investing has been made to appear like rocket science while in reality it is pretty simple if you understand one simple fact: people running the markets know just as much as you do. They might drop around fancy words like regression analysis, derivatives, options, swaps and what not but in reality these instruments are way too often used used by the general public without the nomenclature for instance, you go on Facebook to buy something and ask the seller to put it on hold for you, that right there is an option contract you just made- an ‘option’ to buy the good at a later date. Or let’s say you have go to your buddy to borrow some money, but he/she is a very stingy person (a very important element towards achieving financial independence) and doesn’t take you for your word and wants some sort of backing in case you can’t pay him back. You think hard about something that you don’t use and wouldn’t mind giving away if things go really bad, and if that could bring him a sense of safety, it could be a win win for all, with you getting the short term loan and him being secured. Now that the collateral has been decided, let’s say, your Rolex (stop buying such things guys, and follow the entire thread to learn more such tips and tricks), it’s time to decide how much money you get from the lender. This amount will be decided by how much value the watch is pegged at, which in itself is a very subjective thing. So after long arguments (being the stingy guy he is, he buys fake Rolex’s to flex, while shelling a tenth of what others do. SMART!), you both agree that the Rolex would be worth 3000$ in the market at the given prices and he could give you $3000 in loan with the Rolex as collateral. That’s it, that’s kind of a derivative contract you just signed off. The value of your loan or to generalize, the value of the thing you want, is being ‘derived’ by some underlying instrument, in this case it’s a Rolex. Had the underlying instrument been something else, let’s say, your house, the amount of money you could have gotten would have been different depending upon the value of the house. So the next time you watch The Big Short with your friends, being the iMarche Learning Patron that you are, act smart and teach them a thing or two.
Now like the two instruments we covered above, we have 1000s more being formally named and traded, millions more in everyday use without any names, and mathematically speaking, there could be an infinite number of such instruments. Let’s get some terms clear- a financial instrument is nothing but a contract and a contract is nothing but an agreement between two or more parties. That’s it. It’s that simple. Contract could be anything, you and your friend agree to meet at your house at 4pm, this coming Sunday, you just made a contract. A financial contract is simply an extension- the stingy guy ( he’s gonna be an essential part of our series on how to achieve financial freedom so let’s name him- Edan, if you Guys have any better suggestions, do leave them in the comments below) invites you over for lunch, but also asks you to bring $10 to pay for the food prep. you agree. There you go, a financial contract. As you must have started to see now, there are infinite such contracts possible, and instead of getting you overwhelmed, we are here to make things easier for you.
Being an investor myself, before taking any decision, I always always always lay out my objective map i.e. what is it that I want and what I am willing to sacrifice. This extends to all realms of life but I’ll try to focus only on investing for today. Let’s bring Edan back into the story to make things easier to understand. Edan, just like any other person wants money, lots of money, for? Anything, nothing, everything, he just wants extra money, more than what he has right now. What next? He googles investing options in Canada. Jesus, there’s 100s of thousands of pages, which one to go to, who to believe in, what to do? He is literally having a panic attack. Hold on Edan, hold on. Google will almost always make things harder, is there a better way?
There sure is. You gotta understand one simple point in life, be it in investing or any other sphere of life. The greater the returns, the greater the sacrifice. In investing, such a parlance can be drawn between return and risk, the two foundational R’s. All the fancy models being drawn out by PHDs, physicists, mathematicians and computer scientists try to maximize their returns vs the risk, spending millions and millions in research just to get that optimal Risk-return ratio, with the main objective being to minimize risk and maximize return.
Now you know the basic relationship, you go on a little journey trying to explore what your risk tolerance and time frame is, you have come a step closer to finding what the right investment is, all by yourself!
What next? You gotta question whether you have the energy and ability to do the research yourself, if that’s the case, then you are what financiers call active investor. That’s a whole another domain, requiring lots of research, effort, time commitments etc etc etc. Some of you literally just changed your opinion as I wrote the above line. You know what, I am not an active investor anymore, is there something else I can do to make lots and lots of money. There sure is. Passive investing is the answer if you don’t have the commitment to put in lots of effort.
Passive investing is a completely new area of investing which has changed investing over the past few years. Now, instead of doing all the research that would usually take a lot of manpower, still not minimizing risk and getting you the optimal solution/product/return, passive investing simply, as the name suggests, is choosing a product that tracks some sort of index, which is like putting your money on auto-pilot. There are a lot of investing platforms coming up these days like iMarche.ca, which help you navigate through around 150+ mutual funds offered by Canadian AMCs.
Stay tuned for more updates to learn more and let the fear of investing shy away!