Sage Investment Advice for the Novice

by Darwin on June 5, 2017

What constitutes a good investment? From a theoretical perspective, it’s a no-brainer. A good investment is one which generates positive returns over time. The risk/reward ratio is favorable to the investor. Investments come in many forms, and across multiple asset classes. The broad range of financial assets that are available to market participants include stocks, indices, commodities, currencies, and Treasuries. Positive returns can be generated by diversifying your portfolio across asset classes, and international boundaries.

The global economy is in a constant state of flux. Currently, the US economy enjoys a historically low unemployment rate of just 4.3%, a GDP growth rate of 1.2%, an inflation rate of 2.2%, and an interest rate of 1%. Simply put, the US economy is on track for another year of strong gains. While NFP data disappointed slightly in May, the Fed is likely to move ahead with a rate hike on the federal funds rate on June 14, 2017. Current projections by the CME Group FedWatch tool have the probability of a rate hike at 94.6%. This means that if the FOMC pulls the trigger, the FFR will rise to 1.00% – 1.25%. This will raise demand for the USD, cause a decline in demand for dollar-denominated commodities, make imports cheaper, and worsen the trade deficit.

Markets Are Pricing in a Possible Rate Hike

From a tactical perspective, traders and investors can certainly benefit from an imminent rate hike with currency pairs trading. If the base currency is the USD, then call options are warranted, for example: USD/ZAR, USD/EUR, USD/GBP, and the USD/CAD. If the base currency is the GBP, EUR, JPY or ZAR, then put options are required. The reason a Fed rate hike is good news for dollar bulls is simple. Increasing interest rates have the effect of draining the money supply in the economy. People are more likely to deposit funds when the rate of return is increasing. Conversely, people are less likely to apply for credit facilities when the cost of that credit is increasing. In both cases, the total money supply decreases slightly. Since the interest rates are still at historic low levels, the impact of a 25- basis point rate hike is minimal.

Meanwhile, Wall Street is on a roll. The Dow Jones, the S&P 500 index and the NASDAQ composite index have shown strong gains over the past 1 year. The Dow 30 is currently at 21,206.29, up 7.31% for the year to date, and 22.16% over 1 year. The S&P 500 index is currently trading at 2,439.07, up 8.94% for the year to date, and 18.65% over 1 year. The NASDAQ composite index is trading at 6,305.80, up 17.14% for the year to date and an incredible 29.20% over 1 year. These numbers are startling given the geopolitical uncertainty that has racked global markets recently. The Brexit referendum (June 23, 2016) rattled the UK economy, sending the GBP plunging to decades-long lows, while European elections have called the unity of Europe into question. Geopolitical concerns with North Korea, China, and Russia continue to dominate the headlines.

What Is a Safe Investment for a Newbie?

Novice investors are naturally scared off by all the unknowns. It’s difficult to know whether currencies, commodities, indices, or stocks are better than leaving money in the bank. Even before you invest a penny of your hard-earned income, it’s important to identify your risk appetite. Risk-averse individuals will do well with a financial portfolio that is based on the aggregate performance of the market or a sector, as opposed to individual stocks. There are many safe investments such as mutual funds, ETFs, and managed portfolios. For a more risk-seeking investor, individual stocks are the ultimate investment. If the stock flies, so too do profits. But a caveat is in order: individual stocks are extremely volatile and large gains/losses are possible from day-to-day.

The Trend Is Your Friend

Whether you go with an aggressive growth portfolio or a safe portfolio, it is important to diversify between underlying financial assets. I have learned from my experiences trading with Lionexo that the best options are those which counterbalance one another in the event of a hiccup. Gold ETFs and gold shares should be included in a portfolio that is heavily invested in individual stocks and/or mutual funds. Gold is a natural hedge against geopolitical uncertainty. If the stock market suddenly crashes, demand for gold will increase. This may not immediately translate into a higher share price for gold shares and funds, but over time it will. Remember, there is always a lag effect in financial markets. Sometimes things like Fed rate hikes get priced into equities markets well ahead of time. At other times, a higher gold price will take time to cause a concomitant rise in gold stocks.

Stay the course – market movements are cyclical, but the long-term trend is generally positive.

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