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Why invest in the stockmarket?

THERE are basically two ways to earn income in this world. One is by providing your own labour in exchange for money. The other is by making your money work for you. It's what the rich already know - it takes money to make more money. And this is what investing is about.

To be sure, investing does have some risks. However it also provides you with the long-term potential to make you wealthy, which money kept in the bank can't really do. Consider this: interest paid on a bank savings account hardly keeps pace with inflation. If the annual interest paid is lower than the inflation rate, then the net effect is that you are actually losing money.

Compare this with the returns from investments in unit trusts, for example. In 2007, the average returns from unit trust funds that invests in stocks was about 109 per cent over five years - that's just over 20 per cent a year. Bursa Malaysia's Kuala Lumpur Composite Index, which reflects the price performance of the largest 100 listed companies on the local stock exchange, was almost 32 per cent higher at the close of 2007 from a year earlier. Since 2002, the KLCI has more than doubled, averaging about 25 per cent growth a year.

In case you're wondering, double storey terraced house prices in the Klang Valley rose by between three and just under 10 per cent in the first nine months of 2007, according to a report by property consultants VPC Alliance (M) Sdn Bhd. Between 2002 and 2006, the Malaysian House Price Index, a national average compiled by the valuation and property service department of the Ministry of Finance, had increased by 14 per cent.

Lately, the performance of the world's stock markets have generally come off the pace, owing largely to the economic and financial turbulence in the US. That is the risk that a stock investor will have to take. Risk accompanies any type of investment, but can be mitigated or minimised through knowledge and research. Indeed, investing in stocks has consistently proven to be one of the most profitable forms of investments available.

What you should keep in mind is that investing is for the long term, which means the investor has to ride both the highs and the lows of the market. More often that not, stock values appreciate over the longer term. Secondly, you should invest regularly, buying both during market highs and lows, which in effect will lower the average cost of your investments. An investing strategy based on timing the market, where you try to buy as prices are about to take off, and sell as they peak, may not necesarily be the best way as even the professional fund managers can't get it right the majority of the time.

Investing versus speculating

You've probably heard many stories of fortunes made and lost on the stock market. And that speculating in stocks is akin to gambling in the casinos? There is a marked difference between investing and speculating. Investing is for the long term, and requires patience. Speculating is for those who can't wait and want quick returns. See the difference? The secret to successful investing, as many experts would share, is doing your homework. Find out what the investment is about, the risks involved, and the costs. If it sounds too good to be true, it probably is, in which case you should walk away.

Before you make the call to a stock broker, there are additional steps you need to take:

Setting your financial goals

Why are you investing? Is it to make money for your next holiday, to save for the downpayment on a new house, to fund your retirement, or to pay for your kids' college education? Once you've figured out how much money you need and how long you have to get there, next thing you need to do is deciding how much you can afford to put aside on a regular investing plan. These will help you get to the next step, that is determining what type of investments would be suitable for you.

Determining your investing style

How do you view risk? Are you gung-ho or prefer the safe route? How much time do you have to monitor your investments, as well as how long before you want to begin enjoying the returns? If you're young, you can afford to take some risks with your investment as your primary goal would be to grow your capital. Even if some investments don't give you the expected returns, time is on your side which will enable you to look for better growth alternatives elsewhere. However, if you are closer to retirement, then you would want to preserve your nest egg and seek out investments that give you regular income instead, such as interest from government savings bonds or stocks that consistently pay high dividends. Investing in stocks may seem risky at first due to the short term volatility. But you can build your risk tolerence and learn to be comfortable with the market's inherent short term risks if you focus on the long term, once you have a better understanding of how the market works through research and experience.

Active and passive investing

How much work do you actually want to do when picking out the stocks to invest in? Active investors, either on their own, or through unit trusts funds, regularly review their stock holdings. What they want is to keep a portfolio of winners, buying those with potential and selling off stocks that underperform. Can you imagine the amount of research necessary to pull it off? Passive investors are those who prefer to put their money in something that tracks key stock market indices, such as the KLCI. If your view is that the local stock market will grow strongly over the long term, buying the index fund leaves you without the hassle of actually picking the individuals stocks that would mirror the index's growth.

Being passive has its benefits. For example, the actively managed equities unit trust funds on average failed to better the KLCI's performance over the five years to 2007. There were some star performers, of course, unit trust funds that handily beat the index during the period. However, the point is that it is not as easy as it sounds. If you're happy with the potential returns from an index, options to consider would include any of the FTSE Bursa Malaysia index funds, which are traded like stocks and can be bought and sold during market trading hours through a stockbroker.
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