Guide to invest (II): eleven economic concepts

This text is the second part of the investment guide we published a week ago.

To be used with the key vocabulary of the subject we deal with will help you to see which variables interact in the result of an investment. In addition to our glossary we will give you five tips. Both the vocabulary and our recommendations drives you to the best investment decision.

 Eleven basic economic terms for investing:

1. Savings: surplus of any economic good at the end of a period.  We can commonly speak of setting aside a percentage of the monthly income in order to save it for the future.

2. Rent: amount of income that occurs within a period. An income, being associated with a period of time, is a "flow variable".

3. Wealth: total of financial and non-financial assets.

The financial assets are: bank deposits, stocks, fixed income securities, bonds, equity securities, etc.

The non financial assets are: real estate, vehicles, etc.

Any wealth -financial or non-financial- is owned at a given date. Wealth is a "stock variable" because it is measured at a given instant.

4. Liquidity: capacity of a person or company to convert its own assets or goods into cash quickly in order to meet short-term payments.

5. Solvency: capacity to meet payment commitments agreed with third parties, whether liquid or illiquid (provided that these illiquid assets represent an adequate backing to settle debts), 

6. The interest rate: the money price in a transaction. In the same way, this indicator fixes the value of money in general terms and shows the profit or loss recorded by a given investment - in a given period - and does so in a figure expressed as a percentage. 

7. Consumer Price Index (CPI): this is the indicator that measures the variation in the prices of the products most used by consumers and the purchasing power of families in a given place and at a given time.

When the CPI is inverted, it is a key factor because when there is inflation you must add money to assure that your investment does not fall in real value,  

8. Profitability: "index that measures the relationship between the profit obtained or to be obtained and the investment made or to be made to obtain it". Source: crecenegocios.

9. Gross profitability of the property: this is calculated taking into account the cost of the property and the annual income received from renting it.

Practical example: "if we buy an apartment that costs us €100,000 including purchase costs and taxes. And we rent it for 450€ per month. We have a gross profitability of:

Purchase price = 100.000€. 
Gross Income 450€ * 12 months = 5.400€. 
Gross Profitability = 5.4% "

Source: inmoactivox

What was the real gross rental yield at the end of 2020? 

Last year saw the biggest contraction of the Spanish economy in 80 years: -11%.

However, the gross rental yield was +3.7% according to the Bank of Spain (BdE in Spanish) which is obviously an independent body with respect to our sector. By way of comparison in 2020 government bonds "yielded" 0.0% according to the same BdE.

The economic newspaper CincoDías published the main evaluations of the rent in 2020 in our sector. The news we have just linked includes the figure already commented, but we wanted to separate the BdE from the sector sources. This way you can see how positive are the data concerning renting is.

Net profitability of housing: the result of subtracting from the gross profitability the expenses derived, for example, from: taxes, repairs, community costs, etc. 

10. Simple interest: interest is the amount charged on an investment for the use of money. Three factors are involved in the calculation of interest: capital, interest rate and time. 

11. Compound interest: "is the accumulation of interest on capital over a given period (usually during several years), so that the benefits are multiplied.

Compound interest is derived by adding successive interests to the principal interest. It happens then that this interest also generates interest, which produces a multiplier effect of money over time". Source: eurekers. Compound interest is what accelerates capital gains.

 2. Tips to invest 

Treasuring: training, skill and instinct to invest successfully has enormous social prestige. For this reason, many people give a lot of advice.

We prefer to be concise:

1. Invest in an asset you understand: Warren Buffett calls us to have judgment as investors. To do this you must understand and, therefore, be able to explain what type of business you are "putting your money into".

Real estate is one type of investment that meets Buffett's condition. Namely, everyone knows what a: house, premises, office... what they are for and, above all, that the market values real estate products. Thus, although its value may depreciate, this asset is tangible and, in the medium or long term, has a less volatile market value than other assets, for example, those linked to the Internet. 

2. Get expert advice, learn about the evolution of the asset and plan: understanding the asset is necessary but not enough. Now it is time for expert advice. You must be able to ask your advisor questions. Naturally, trust is essential for any advice, from the moment you agree to be advised, you team up with your advisor. In the same way that you ask questions, it is essential to be informed of the evolution of the asset and that together you plan the objectives to be achieved and in what term. 

3. Investing is a long-distance race: our Head of the Commercial Area accurately reflected our philosophy: "If you look at the forecasts of reputed economists on television, nobody gets it right (...). We work for people who do not expect stratospheric capital gains in the short term (...)". In short, in order to collect capital gains, we prescribe patience and to always keep the trend in mind, that is to say, not to look too often at the evolution in the short term.

4. Be smart: is better to prepare for the worst scenario compaired with always hope for the best. Pessimism is associated with prudence and optimism with irrational emotion that can make us be impulsive and forget that the human being has a weakness for quick profit.

5.  Change your strategy with advice: circumstances change and, although in general you have to have method: "the duty of a serious investor is to accept the depreciation of his portfolio with equanimity and without reproach" (John Maynard Keynes). As Tim Harford recalled in an interview: "Fisher, who was ruined by refusing to rectify his investment strategies in the crisis of '29, and Keynes, who suffered the same, knew how to rectify and bequeathed a fortune to his university". 

In this text we have introduced you to the world of investment, in the next one we will focus on real estate.