The Balance When It Comes to Investing - By Shiela Nikrote
With economic situations proving to be tough by the day, every opportunistic person has a mad ambition to increase their coin. In every sense, corporations have not been left out. Maximization of shareholders wealth has been the bottom line for many companies and by no doubt this has been termed to be rational.
As an individual investor, you will find the big institutions to be quite promising. It is disheartening to learn however, that without proper boundaries, the chase for more profits has led to unfathomable situations in the financial arena. Let’s take a delve at this, shall we?
Too big to fail?
The mentality of too big to fail has crippled financial institutions in large measures. This stems from the perspective that big banks have concerning being immune to market shocks. The shell that big banks use as a protective measure is that they have healthy financial performance and also a big market share. As such, most big banks are reckless when it comes to lending.
In the past, this has led to huge economic meltdowns as giant financial institutions such as Lehman Brothers Investment Bank being left bankrupt and a ripple effect among other institutions being felt.
Where to draw the line
As an investor you are left to wonder if there is any moral compass when it comes to granting of credit. I mean, if banks have a lot of capital, they are free to engage in business freely, right? In a common man’s view this appears simple. However, there is a lot of responsibility that comes with easy lending.
Every financial institution has a moral responsibility to conduct thorough research before passing out credit. This is with a bid to avoid moral hazard, a situation that arises when banks are negligent in their due diligence. This in effect increases the credit risk leading to further losses.
Given that banks hold a lot of depositors’ money, the use of such money needs a lot of caution and this is where banks should draw the line. If the potential borrowers have a high risk of default especially where there is no collateral, there is a huge red flag and lending should be avoided.
What’s the fuss about?
In case you are wondering why it’s a big deal to look at big financial institutions lending habits it is because the ripple effect negligent lending is huge. Such a situation is clearly depicted in the infamous financial crisis when Lehman Brothers Bank failed. The bank has been way too lenient and extended credit to masses of people who were keen to obtain mortgages. Overtime, the houses became increasingly appealing and more people lined up for the loans. The bank, seeing the profit that they would gather did not hesitate.
Ultimately, what happened is that house prices due to the increased demand sky rocketed. Afterwards, the insane value of houses and a lack of genuine logic by the masses came to a halt. The prices came crippling down affecting many a number. Imagine having a house whose value is less than the loan you are paying for. Devastating, right?
Economic downturn?
As if the individual problems were not enough, there was a mortgage crisis in the financial institutions and a contagion effect to other bank and non-bank institutions leading to a financial meltdown across the world. The financial market was not spared either. The stock prices met a devastating fall all this stemming from one huge bank.
Final resort
By the time losses due to negligent decisions become overwhelming and news spread widely, institutions usually employ measures to prevent the huge impact. However, at this dark time no one is willing to have an element of faith on any collapsing firm. The nightmare of bankruptcy begins and failure beckons. This is the reason your concern should be on the rise as saving a big institution needs leaps and bounds as much is required.
The portfolio remedies
You will learn rather quickly that if you had all your money in the big institution you would be at an absolute loss. This is not to say that big corporations don’t make profits. The biggest lesson would be to have proportions of your money on different stocks as this will spread your risk. Indeed, carrying your eggs in different baskets would have you at an advantage of being in different industries potentially increasing your returns.
Multiple streams of income
Another great idea when it comes to investing is to put your money in different businesses. As an investor you can place some of the money in rental units, others in purchase of cars and in fast moving business.
Similar to the portfolios, this will generally spread your personal risk and boost your income in folds. At any given time, the underperformance of one industry will not have you completely out as other sources of income can help hamper the loss.
Be aware of the news
Part of being a good investor is generally being inquisitive on the information in the market. News release could mean looking into investing in a stock or not buying the given shares just then. Also, if you borrow to invest, it would be a great idea to look at interest rates as different institutions offer competitive rates with some even having relaxed terms.
Capital gains versus dividends
If you are interested in realizing short term increments in your money after upward rise in the stock prices or general increase in revenue, then dividends will give you a great boost. At the end of a given period of years, you can sell your shares to obtain the lumpsum amount and thus have a huge capital gain. Some companies give investors the option to choose between short term and long-term gains so be on the lookout.
Bottom line
When it comes to investing for personal gains, financial success can be achieved. Diversification is a master key when it comes to financial markets and also when considering having multiple channels of income. Keep in mind that investing requires discipline and not impulse as it is a long-time venture and your path will steer well.