Question

Assume you have a $50,000/year income and live here in the GTA. What sort of financial products would you most likely to invest in, and why? Explain both the pros and cons of your choice. Is your decision based more on rational analysis or emotion?

Answer 1

Financial products are investments and securities that are created to provide buyers and sellers with a long term or short term financial gain. Financial products can help us grow the amount of money we have to meet various financial goals, such as retirement, children’s education, marriage and so on.  These are issued by various banks, financial institutions, stock brokerages, insurance providers, credit card agencies and government sponsored entities.

Types of financial products :-

Shares - These represent ownership of a company. While shares are initially issued by corporations to finance their business needs, they are subsequently bought and sold by individuals in the share market. They are associated with high risk and high returns.

Treasury Bills - These are instruments issued by the government for financing its short term needs. Rate of return is low but we get is the sovereign security on the principal amount.

Mutual fund - It is a professionally managed type of collective investment scheme that pools money from many investors and invests it in stocks, bonds, short-term money market instruments, and/or other securities. By investing in Mutual Funds, one can have benefit of diversification.

Bonds - These are issued by companies to finance their business operations and by governments to fund budget expenses like infrastructure and social programs. Bonds have a fixed interest rate, making the risk associated with them lower than that with shares.

Annuities - These are contracts between individual investors and insurance companies, where investors agree to pay an allocated amount of premium and at the end of a predetermined fixed term, the insurer will guarantee a series of payments to the insured party.

Collateralized Debt Obligations (CDO) - These are securities that are created by collateralizing various similar debt obligations such as bonds and loans. CDO can be bought and sold. The buyer gains the right to a part of the debt pool’s principal and interest income.

If the $50,000/year income is to be invested, one of the most significant factors to consider when choosing financial products is your risk appetite. Risky investments are usually associated with higher returns than safer investments. According to empirical data, shares usually outperform all other investments over the long term.

Thus, a person investing for the long term having a high risk appetite will be better off investing a greater portion of his income in shares. On the other hand, individual with a low risk attitude can go for bonds, because it gives safety of principle, assured returns & low volatility.