Taking Note of Investing Environment
From Financial Literacy Wiki
Taking Note of Investing Environment
The focus of the four-step personal financial planning process is on your financial resources, your goals and your plans and implementation. However, it is important to realize that the outcome of your plans depends on both your actions as well as the actions of others. Other key players can also affect the outcomes of your plans. These include other investors, the financial institutions and the government. It is the aggregate interactions of all these players that determine the outcome of any financial investment.
When planning, you should understand the government’s policies and regulation especially those that are monetary and fiscal in nature. The monetary policies of the government affect the money supply, the reserve requirement and discount rate. These, in turn, determine the interest rates and inflation rates in the economy. The fiscal policies of the government relate to taxes and government expenditures. These policies can lead to an expansionary or contracting effect on the economy. The aggregate impact of the government policies and regulation can ultimately affect the returns that you generate from your investment.
Before committing your hard-earned money to risk investment, it is necessary for you to understand the unique characteristics of the individual financial markets which you wish to invest in. Financial markets are of varying degree of efficiency. Efficient markets tend to incorporate new information very quickly so that it is difficult to exploit the information that has been released to the public, these are usually found in markets whose infrastructure are well developed and there are sufficient buyers and sellers in the market.. On the other hand, inefficient financial markets incorporate information slowly and hence prices tend to register trends. By being close to the market grapevine and by studying the price trends and volume statistics (also known as technical analysis), you may be able to outperform the market.
Most asset markets undergo periods of boom and trough. In other words, there are price cycles in financial markets. Understanding how asset price cycles are related to the business cycle would help you to invest your money at the most opportune time.
One way to understand the business cycle is to study the trends of major economic indicators. Some of these indicators are leading indicators in that they ‘lead’ the business cycle. By focusing on the performance of the leading indicators, you can forecast where the economy is heading, growth or contraction phase.
The other financial variables that should you should pay particular attention to are inflation rates and interest rates. In a highly inflationary economy, holding cash results in decreasing purchasing power. It is worse, if you are investing in instruments that generate a fixed income. Hence, if inflation rates are high, it is prudent for you to invest in instruments that hedge against inflation, such as property or common stocks or index-linked bonds.
Investors should also keep track of interest rate fluctuations. In an environment where the interest rate is high, the opportunity cost of investing in risky assets is also high. This is because the investor can always put his money in fixed income instruments such as bonds to earn a higher interest yield. If you are a borrower, a high interest rate means a high cost of investment. Hence, whether you are an investor or a borrower, it is necessary for you to monitor the interest rates prevailing in the market.
