So, what exactly are bonds?

Companies typically have two ways of raising cash when they need to expand their businesses or need it for a mind-boggling number of needs. One is by going public and diluting their ownership of the company to investors who would all pay a morsel (share price) and claim ownership: stocks. Another way of raising money is the age old method of borrowing: bonds.

Companies can borrow from the investors themselves and when each of the investors lends out even a small amount like $1000 it quickly rolls into a huge sum of money which the company can use for its expansion or other needs. Usually the federal government also borrows money from the investing public (these are the government bonds) for its own use. All of this money is returned to the public in a periodic manner with interest paid on the sum borrowed.

So typically, a bond is nothing but a loan that you hand out to companies or the government itself. The loan is paid back to you (an investor) within a scheduled time and at a specific, pre-determined interest rate (also known as coupon rate). The borrower (the company or the government) would have agreed in writing to pay back the borrowed amount (called as face value, in bond parlance) at a fixed date into the future which is when your bond matures ( the amount would have been paid back to you in full with Interest) and this date is called as the maturity date.

Since you always know how much you are owed exactly, these investment vehicles are less risky, more stable and hence they pay less compared to stocks. They are often called as fixed-income securities or debt-market instruments to reflect on the fact that they are predictable, more stable, pay less but don’t fluctuate wildly.

Between the two important investment vehicles — debt (Bonds) and equity (Stocks), there is this major difference. When you pick stocks, you claim ownership of the company, complete with voting rights and the works - you make money when the company you invested in makes money. When you buy bonds, you become a creditor to the company and in principle, when push comes to shove and when companies have to liquidate for some reason, the creditors are given the first preference and the bond investors are paid up first.

Over the past few years, the example given above has been pushed to the maximum and has caused what we now know as the Global Financial Crises - Link to a great video to show how it happened

PD

I get many articles passed along my desk form a variety of different fund managers and insurance companies. This article is taken from a news release from Vanguard Investments that I’m sure you will find interesting as I did.

Lessons learned from a tough year

After a financial year that most investors would want to forget, a worthwhile exercise is to ask what has been learned.

Perhaps most crucially, investors have been unequivocally reminded during 2008-09 about why some of the most basic principles of sound investment practice make a lot of sense.

When the economy is strong and sharemarkets are rising, some of these straightforward principles are overlooked. And it can take a bear market and economic woes to bring them back into stark focus.

Here are just a few of the principles to be truly reinforced over the past 12 months:

Keep it simple. Many investors lost a lot of money in 2008-09 by being involved with complex investments that they could not really understand. If an investor can’t comprehend how an investment operates, the message often repeated by the likes of the Australian Securities & Investments Commission (ASIC) is clear: stay away from it.

Keep investment and personal debts under careful control. We have heard scores of extremely sad stories over the past year of older couples borrowing against the equity in their homes to invest in shares that were, in turn, heavily geared. This double-jeopardy approach to gearing truly exposed these investors to the full impact of the bear market. It provides an extreme lesson to all of us about the dangers of excessive debt.

Gearing works both ways. This ever-green lesson is linked to the previous point. The fallout from the bear market has been a telling reminder that while gearing can magnify gains in a rising market, it can do the opposite in a falling market.

Act your age. Many older and inexperienced investors were among the numerous investors who had become caught up with the euphoria of once-rising share prices and overlooked the need for the most-appropriate diversification of their overall investment portfolios. As good financial planners often remind their clients, the diversification of a portfolio should reflect an investor’s personal circumstances which include such factors as personal tolerance to risk, investment horizon, age, and expected years until retirement.
Look to the longer term. Particularly when the sharemarket becomes highly volatile, investors are vulnerable to over-reacting to day-to-day news and market commentary. Investors who concentrate on the longer term usually try to block out much of this daily “market noise”.

The 12 months ahead will set particular challenges for investors. Some cashed-up investors, who may be more optimistic about the prospects for share prices, may attempt to time their way back into the market – by trying to pick the best time to buy. Market timing is something that even seasoned investors rarely get right.

Financial planners often recommend that their clients “drip-feed” large amounts into the market progressively over an extended period rather than investing a large amount at one time. This is a form of dollar-cost-averaging.

Another challenge will be how investors react to the cutting back of the caps on concessional superannuation contributions – which include salary-sacrificed contributions as well as personally-deductible contributions by the self-employed and eligible investors without employer super support. The reduction in the caps may encourage some investors to increase their gearing of non-super investments without fully acknowledging the extra risks involved.

So, like I always say, make sure you know as much as you can about where your money is invested and research, research, research.

PD

A MAJORITY of Australians say they know the exact fees on their main credit card but almost half have still been stung with late payment fees and a quarter have been hit with with fees for not paying enough of their monthly bill, a survey reveals.

This contradiction between knowledge and behaviour is further illustrated by almost a third of the respondents to the news.com.au credit card survey saying they knew the interest rate on their card.

This is concerning because the amount of money people put on their cards, and ‘kind of’ budget to pay it off, is huge. I know when I pay on my credit card, I tend to think about it later, then forget and have to pay the interest at the end of the month. It’s annoying, but my fault entirely. But at least I know what my interest rate is. I don’t think about it, because it seems incomprehensible that they are even allowed to charge that amount on a card.

The good news, it seems, is 44.8 per cent of respondents said they paid their credit card debt in full and only 12.8 per cent said they only made the minimum monthly repayment.

The survey also found that more than half of all respondents - 55.2 per cent - had been asked to pay a surcharge when using their credit card to make a purchase at a business or in a shop.

The respondents to the survey were most male - 68.6 per cent - and more than half of had a gross household income above $75,000 per annum.

Pay off your monthly bill

It seems like an obvious one, but the amount of people who never pay off their monthly debt is staggering.

Ignoring the minimum monthly payments on your plastic is the sure way down the rocky road to insolvency, says entrepreneur and author Tony Melvin.

“Killer debt must be paid off as soon as possible.”

By accumulating credit card debt, you are ripping yourself off in the future, because it’s the future you that has to pay off this debt, he said.

“Money management is more of a time game than anything else. To avoid debt, you need to make sure you set aside money for the present and the future.

“People’s problem is that they spend their future money - that’s what using credit is.

“By doing this, you are really ripping yourself off as it’s the older, tireder, harder working you that has to pay that off.”

Credit card tips:

You hear this all the time, and it might almost seem like a cliché, but if you have a substantial credit card debt, you should look at finding a lower interest rate, and tht will help with paying off the debt quicker. There are many different cards that provide this. One such website, which allows you to look for the best credit card is Credit Card finder. You can find them at www.creditcardfinder.com.au

What is your financial goal?

One goal should be having a ‘profitable’ personal balance sheet. All financial institutions have Profit and Loss Statements and Balance Sheets to show how profitable or behind they are.

Have you done a Personal Balance Sheet? Would it be pretty? Probably not. But this is a sure fire way of starting you on the right track and keep you ‘profitable. I’ll explain what I mean about being personally profitable in another post.

Set aside 10 to 20 per cent for future needs, no matter how much debt you are in. If you have killer debt (debt against things not going up in value such as cars or televisions) you need to pay this off as soon as possible.

Have a future investment fund of 10 per cent.

Live off about 60 per cent of your income. With that discipline in place, you will pay off your killer debt.

Put aside 5 per cent for education needs (business, investment) and 5 per cent for emergencies.

People who get rid of their killer debt move into a position of control. This is the principle of how to become solvent – which simply means you have more asset than debt, a positive net worth.

For more information on becoming solvent in your financial life, visit www.solvencymakers.com

PD

Research published this week by the University of Melbourne Centre for Corporate Law and Securities Regulation challenges some common perceptions about personal insolvency.

The headline numbers are disturbing enough – a 261% increase in personal insolvency between 1990 and 2008. But more interesting is the impact of easier credit, and the explosion in the use of credit and debit cards among Australian households.

According to the report written by Professor Ian Ramsay and Cameron Sim, excessive use of credit caused 13.3% of non-business related bankruptcies in 1997. By 2008, that figure had climbed dramatically with excessive use of credit accounting for 39.4% of non-business related bankruptcies.

Now, given the current economic climate, it is reasonable to expect that the rate of bankruptcy is likely to continue to rise, particularly as unemployment rises and more people struggle to meet financial commitments.

But the profile of people becoming personal insolvents is changing – they are more likely to be employed, older and have higher levels of personal and household income. Personal insolvency is definitely becoming more of a middle class phenomenon.

Since the global financial crisis started to bite, the good news is that the rate of growth in credit card debt has slowed significantly and households have been reducing debt. Perversely, that was not want the federal government wanted to happen as they were busily trying to stimulate consumer spending, but individuals sensibly took the chance to reduce personal debt.

But outstanding balances on credit and charge cards accruing interest, according to the Reserve Bank data, was $32.9 billion at the end of January this year. Rewind 12 months to January 2008, and the outstanding credit card balances accruing interest was $30.6 billion - so despite the global financial crisis credit card debt continues to climb. And despite the fact that money is pouring into bank term deposits, courtesy of the government guarantee and official interest rates falling steeply, interest rates on credit cards remain stubbornly high.

Mainstream rewards-based cards have an interest rate of 17.9% and cash advances are being charged interest at 20.9% on some leading cards.

Investors are understandably concerned about returns on their superannuation funds and the outlook for investment markets. But for many people, focusing on reducing the cost of servicing credit card debt could be a more effective strategy to improve their overall financial position. No-one can control market performance, but we can all control the amount we pay in fees to financial institutions – be they credit card companies, banks or fund managers.

PD

The year of the handout. Some people could replace their salary with the amount of money being given by the government this year. Don’t get me wrong, free cash is great if you can get it, but is this something that will actually help the economy?

I realise that the stimulus packages are ‘designed’ to get people to spend money in retail and keep that sector going, but what about some of Australia’s 1.8 Million small business who employ over 47% of the entire Australian workforce who represent 95% of ALL businesses? These people, myself included (so I am slightly biased here) are doing it just as tough as retailers, but are still slugged with payroll tax, superannuation guarantee contributions, workers compensation, and on top of that having to worry about generating new business. It’s a long way off before many actually turn a dollar for themselves!

Instead of partaking in a massive money throwing orgy, why not reduce the burden of payroll tax to the small business, and possibly throw them a SGC bonus for their employees? Pardon my sinnacle thoughts, but may it be that it not buy popularity in the voting polls? Any three year old can work out that giving money away to the public will generate some spending activity, but as we have seen over the past few months, people haven’t spent nearly enough.

If you don’t know if your job is secure, how likely is it that you will go out and buy a plasma or a new bike? That is why, if you benefit the employer in some way, they are less likely to lay off staff due to an ease in cashflow restrictions. People are put in power to think. The ideas expressed here may not be fool proof and solve anything, but at least it has more thought put into it than a second cash splash.

PD

There are many different explanations behind what has happened to the failing world economy. It’s a hard thing to put into words, therefore I will cheat and let the great visualisation expert do it for me.

If you cant see this link, go to THIS LINK at our other site.

I will try to gather more of these films in the future to help put into words some of the more complicated things this finance world has to offer. Enjoy.

PD